The US Internal Revenue Service ("IRS") published Notice 2016-42 on July 1, 2016, which proposes the terms of a new Qualified Intermediary Agreement (the "Proposed QI Agreement"). The Proposed QI Agreement builds upon Rev. Proc. 2014-38, which contains the terms of the Qualified Intermediary Agreement currently in effect for all Qualified Intermediaries (the "Current QI Agreement"). The modifications contained in the Proposed QI Agreement, while not numerous, are significant. Most notably, the Proposed QI Agreement incorporates the new qualified derivatives dealer ("QDD") rules, which relate to section 871(m) and dividend equivalents.1 This Legal Update discusses several significant modifications to the Current QI Agreement that are included in the Proposed QI Agreement.
Effective Date. When the Proposed QI Agreement is finalized by the publication of a revenue procedure later this year or early next year, it will be effective as of January 1, 2017. A QI will be obligated to renew its existing QI agreement through the FATCA registration available at www.irs.gov/FATCA. A QI that is renewing its Current QI Agreement must do so by March 31, 2017, in order for it to be in effect as of January 1, 2017.
A QI that seeks to renew its Current QI Agreement and also seeks to act as a QDD must supplement the renewal request by providing a statement containing all information required by Form 14345 relating to a QDD. The IRS has not yet published instructions on how to file Form 14345, but the Current QI Agreement requires the filing of a paper form, followed by online registration through the IRS website.
Periodic Review and Certifications of Compliance. The Proposed QI Agreement substantially modified the sections relating to the periodic review and certification process. The Proposed QI Agreement provides substantially more detail regarding the requirements of the internal review and the nature of the information provided to the IRS as part of the certification process.
The Proposed QI Agreement adopts a sampling approach, similar to what was required under Rev. Proc. 2000-12, which contained the terms of the QI Agreement that was in effect prior to the publication of Rev. Proc. 2014-38 (the "Prior QI Agreement") and Rev. Proc. 2002-55, which provided guidance relating to external audit procedures applicable to Qualified Intermediaries subject to the Prior QI Agreement. The review contemplated by the Proposed QI Agreement focuses on the testing of accounts and transactions and continues to include the holistic approach that requires an analysis of QI's policies, procedures and controls, which is contained in the Current QI Agreement.
The Proposed QI Agreement contains an appendix that specifies the detailed information the Responsible Officer ("RO") is required to submit to the IRS as part of its certification. This information includes a recitation of all material failures, events of default, changes in circumstances, the QI's FATCA status, as well as other questions relating to the review itself (e.g., accounts reviewed and information on diligence, withholding and reporting). Unlike the Current QI Agreement, the Proposed QI Agreement does not require the QI RO and the FATCA RO to be the same person.
The Proposed QI Agreement provides additional detail regarding the persons who may undertake the required review on behalf of the QI. The Proposed QI Agreement modifies the nature of the internal reviewer's duties and specifies that the internal reviewer cannot review his or her own work, procedures, or results of such review (e.g., the internal reviewer, in reviewing the QI's documentation, cannot be part of the team primarily responsible for collecting and validating documentation). The Proposed QI Agreement provides guidance regarding engaging an external reviewer and similarly concludes that an external reviewer cannot be reviewing systems, policies, procedures or the results thereof that it was involved in designing, implementing, or maintaining. The external reviewer is not required to make an attestation or render an opinion regarding a QI's compliance with the Proposed QI Agreement or compliance with its FATCA requirements, as applicable, but the reviewer must be able to perform the periodic review as specified in the Proposed QI Agreement. Due to this prohibition on utilizing the services of an external advisor that previously advised the QI regarding compliance, QIs will likely need to look to the marketplace to engage new qualified advisors for purposes of this review.
Existing QIs subject to the Current QI Agreement that have not yet provided any certification or an audit with respect to its agreement would be obligated to provide its certification during the 2017 calendar year according to the review procedures that would then be in effect (e.g., presumably the terms of the Proposed QI Agreement as modified by the revenue procedure that finalizes the terms of the Proposed QI Agreement). Thus, any QI that has a QI Agreement with an effective date of June 30, 2014, must treat the initial certification period as ending on December 31, 2017, and will make its required certification on or before July 1, 2018, pursuant to the requirements of the QI Agreement in effect after December 31, 2016. The Proposed QI Agreement appears to waive any audit required under the Prior QI Agreement if the review period would have extended past June 30, 2014. (It is unclear whether this limitation has any impact on any existing QI because the Prior QI Agreement would have expired on June 30, 2014, and it seems unlikely that an audit period would extend behind that date. Perhaps the IRS intended to waive audits under the Prior QI Agreement if the audit cycle included calendar year 2014.) The Proposed QI Agreement also permits a QI to choose which year in the certification period for its periodic review. However, if a QI is also acting as a QDD, it must use calendar year 2017 for its periodic review for the initial certification period because QDD status is not applicable for 2015 and 2016.
Lastly, the Proposed QI Agreement incorporates a procedure for smaller QIs to waive the review process. This waiver potentially applies to a QI that is an FFI that is not acting as a QDD and that is not part of a consolidated compliance group. To qualify for the waiver, reportable amounts received by the QI must not exceed $5 million per year; the QI must have timely filed applicable tax forms; and the QI RO must have made the required certification of internal controls, as well as the applicable FATCA certification based on the QI's FATCA status (i.e., as a participating FFI, registered deemed-compliant FFI, Model 1 FFI or Model 2 FFI). This is a beneficial change to the Current QI Agreement, which did not include any of the three possible waivers from the external audit process available with respect to the Prior QI Agreement.
Joint Account Treatment. The Proposed QI Agreement includes certain modifications to the Current QI Agreement that were previously posted on the IRS website. These modifications expand the FATCA statuses that may qualify for joint account treatment to include ownerdocumented FFIs and all NFFEs, both excepted and passive. Additionally, the Proposed QI Agreement permits a partnership or trust that holds an account that is excluded from the definition of "financial account" under Annex II of an applicable IGA or under Treas. Reg. 1.14715(a) to benefit from joint account treatment.
Limitation on Benefits for Treaty Claims. The requirements for a QI using documentary evidence to document an entity account holder claiming a reduced rate of withholding under an income tax treaty have been updated so that the QI is required to collect information confirming that the account holder satisfies any applicable limitation on benefits ("LOB") clause contained in the applicable income tax treaty. A QI opening an account or obtaining documentation for an entity account holder on or after January 1, 2017, will be required to collect this LOB information. For QIs with pre-existing entity accounts that were documented with documentary evidence, there will be a two-year transition period relating to the collection of the appropriate limitation on benefits information (unless there is a change in circumstances that requires the QI to obtain corrected information earlier). For QIs that documented entity accounts with Forms W-8, those forms may be relied upon until their normal expiration period (unless there is a change in circumstances that requires the QI to obtain corrected information).
Further, a QI will generally be subject to an actual knowledge standard with respect to rejecting an account holder's claim that they have satisfied the relevant LOB provision. This means that a QI cannot rely on the account holder's claim of which LOB provision it satisfies if the QI has actual knowledge that such claim is incorrect. The IRS has not explained what is meant by "actual knowledge" in this context. Currently, it is unclear whether a QI must affirmatively undertake a review to ascertain whether the account holder satisfied the relevant LOB provision. It is expected that additional IRS guidance will further clarify this requirement applicable to all withholding agents.
In addition, a QI will be considered to have reason to know that a claim for treaty benefits is unreliable or incorrect if the account holder claims benefits under a treaty that does not exist or is not in force (e.g., the treaty is not included on the list maintained by the IRS). This reason to know rule becomes effective on January 1, 2017 (or as of the date on which the QI becomes a QI if after such date) for accounts opened and documented after such date and may apply to accounts in existence as of January 1, 2017 (or as of the date on which the QI becomes a QI if after such date) to the extent that such account is subject to a change in circumstances (e.g., a change in residency permits claiming treaty benefit) or, in the case of an entity account, the account holder provides the QI with a written LOB statement.