Since the turn of the century, non-U.S. intermediaries have had the option to mediate access to the U.S. markets by obtaining a Qualified Intermediary (QI) status. Broadly speaking, this involves them signing an agreement with the Internal Revenue Service (IRS) that subjects them to compliance requirements, but benefits them by having a more flexible tax operating model with their U.S. withholding agent.

On July 1, 2016, the IRS released Notice 2016-42 containing a revised proposed Qualified Intermediary (QI) agreement that, when finalized, will replace the current version set forth in Rev. Proc. 2014-39. This new QI agreement introduces some significant changes, as follows:

  • New rules concerning Qualified Derivatives Dealers (QDDs) and any QIs that make substitute interest payments
  • Additional detail surrounding the revised compliance review, including the requisite testing results that the QI must submit to the IRS as part of the Responsible Officer (RO) certification

Summary of Changes

New QDD regime and rules

As background, notice 2010-46 set into motion the IRS implementation guidance on tax on dividend equivalents (DEs) set out in section 871(m) of the Internal Revenue Code (IRC). This notice primarily focused on requirements centering on securities lending or sale-repurchase agreements and provided clarity for security lenders introducing the concept of a Qualified Securities Lender (QSL), which allowed financial institutions to receive DEs free of withholding tax to prevent cascading withholding. In September 2015, the IRS issued final guidance on Section 871(m) which covered a broader scope of DE payments including:

  • those paid on specified Notional Principal Contracts (NPCs) (e.g. swaps)
  • Equity Linked Instrument (ELI) (e.g. futures, forwards, options or structured products)
  • any other substantially similar instrument, where U.S. underlying equity is substantively referenced

The Proposed QI Agreement provides implementation guidance for DEs (including ELIs and NPCs) and introduces the new QDD regime which, once effective, will replace the QSL rules set forth in Notice 2010-46. Qis can decide whether they want to apply for QDD status, which they can utilise for 871(m) transactions where they are acting as a principal party in the transaction.

By operating as a QDD, the QI will assume primary withholding and reporting responsibility with respect to certain DEs on section 871(m) transactions, including DEs paid on NPCs and ELIs.

By representing that it is acting as a QDD on Form W-8IMY with respect to a potential section 871(m) transaction, the withholding agent to a 871(m) transaction will treat the QDD as exempt from withholding on DE payments. This can allow the QDD to avoid the cascading withholding that may otherwise apply when receiving and making DEs. Entities eligible to become QDDs generally include:

  • Regulated dealers in securities
  • Regulated banks that issue potential section 871(m) transactions to customers and receive dividends or dividend equivalent payments pursuant to potential section 871(m) transactions to hedge those transactions issued to customers
  • Entities that are wholly owned by regulated banks and that issue potential section 871(m) transactions to customers and receive dividends or dividend equivalent payments pursuant to potential section 871(m) transactions to hedge those transactions issued to customers
  • Foreign branches of U.S. financial institutions described in the bullets above

To apply to become a QDD, an existing QI can do this via its QI agreement and submission of additional information and documentation requested by the IRS. A new QI can do this via IRS Form 14345. Once granted QDD status, it must act as a QDD for all of the aforementioned payments it makes or receives as principal to an 871m transaction. (Click here for further details of this aspect of the IRC)

The proposed agreement also provides that a QDD must assume primary withholding responsibility under both Chapters 3 (NRA withholding) and Chapter 4 (FATCA withholding) and must assume primary Form 1099 reporting and backup withholding responsibility for all payments it makes as a QDD with respect to potential section 871(m) transactions.

A QDD must document every account to which it makes a reportable payment or qualifying dividend equivalent offsetting payment (or payment that otherwise would have been a qualifying dividend equivalent offsetting payment but for the QDDs failure to obtain a waiver or collect and maintain information about a U.S. nonexempt recipient account holder) in accordance with the documentation rules of the Proposed Agreement.

Compliance reviews
The Proposed Agreement contains significant additions to the compliance review provisions, including:

  • The possibility of a compliance review waiver for small QIs
  • Added flexibility regarding the review period
  • Review requirements more in line with the prior external audit process
  • Detailed sampling information (including safe harbours)
  • Comprehensive lists relating to the information to be included in the reviewer’s report to the QI’s Responsible Officer (RO)as well as the review information the RO must provide to the IRS

Changes to treaty claims

The Proposed Agreement now requires a QI that utilizes the alternative documentation rules for treaty claims to update the treaty statement language to include a certification that the entity meets the appropriate Limitation Of Benefits (LOB) certification described in the new Form W-8BEN-E and, in particular, the specific category of the LOB provision it satisfies.

The LOB clause in a double taxation treaty generally sets forth the ownership or effective management and control rules that an entity must meet in order for it to be considered tax resident in a jurisdiction and, as such, be eligible for the benefits of the respective double taxation treaty.

For pre-existing account holders (e.g. pre-2017 account holders for existing QIs) that are currently documented with the KYC/treaty statement alternative, the QI has two years to obtain the updated statement.

The new agreement also contains two new due diligence provisions relating to treaty claims. First, the QI may not rely on a Form W-8BEN-E or treaty statement if it has actual knowledge that the LOB certification is incorrect. Second, the new rules provide that a QI has reason to know that a treaty claim is invalid if the treaty claim is made with respect to a treaty that does not exist or is not in force. With respect to the latter requirement, for a pre-existing account holder this rule applies only at the time the written limitation on benefits statement is provided or if there is a change in circumstances.

Renewal of QI Agreements and date of operation

Generally, an existing QI can renew its agreement on the FATCA registration website. Note that for an existing QI that is an NFFE acting as an intermediary (i.e., not with respect to its shareholders) must renew its agreement by submitting a request for renewal to the Foreign Payments Practice in New York.

The new agreement, once finalized, will be effective January 1, 2017. For a new QI, the effective date of the agreement will hinge on the submission date of the QI application and whether the QI has received any reportable payments prior to such submission.

Existing QIs must submit their requests for renewal prior to March 31, 2017 to ensure a seamless transition. The new agreement will then have an effective date of January 1, 2017.

Next Steps

Non U.S. financial institutions that are either QIs, non-QIs looking to become QIs or non U.S. Financial Institutions looking to become QDDs will need to review the QI agreement to ensure that they consider applying for a status that best suits their business and tax operating models. BBH U.S. custody has offered products to non-U.S. intermediary banks, designed to provide a platform to be integrated with our clients U.S. tax withholding and reporting models. BBH will be reviewing the IRS progress with the finalization of the QI agreement and, in collaboration with clients, ensuring that our products and services are geared towards helping our clients solve for their QI requirements

For more information, please contact BBH's Global Tax Team.

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