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Last chance to apply for qualifying investor status, as rules take effect Back  
As the new rules for qualifying investor status take effect this month, Gary O’Mahony looks at the options for those companies who haven’t dealt with these regulations yet.
In October 1997, the IRS issued new regulations covering the US withholding tax treatment of certain payments (primarily interest and dividends) to non US persons. The regulations, which are complex and detailed, finally entered into force on 1 January 2001. The IRS has been unhappy for some time with the manner in which the ‘old’ rules were being enforced. In particular, disclosure of US customers had not been occurring to its satisfaction and there was a perception that reduced treaty withholding rates were being applied incorrectly. While the withholding rates remain the same, the collection/reporting mechanisms have changed dramatically.

New regulations - an outline
Essentially, the new rules outline the withholding and reporting responsibilities of both the US withholding agent/custodian (‘withholding agent’) and the non-US intermediary, create new documentation requirements and describe two new intermediary classifications. One of the key points to note is that non-US banks and other financial institutions that invest in and/or conduct US financial transactions, on behalf of non-US investors, need to comply with these new rules in order to avoid an automatic 30 per cent withholding tax. In a worst case scenario, a 31 per cent ‘backup’ withholding tax on gross sales proceeds where certain presumption rules will apply.

It is necessary for Irish institutions now affected by these changes to consider the impact their business and act accordingly. And given that Irish investment in US markets has grown exponentially in recent times, there are many institutions affected. Failure to deal with these changes could significantly affect existing operations in fundamental ways and hamper the ability of such institutions to serve or even retain their existing customers. Doing nothing is not advisable.

Intermediary options
The amended regulations create two new classification categories for foreign intermediaries - qualified intermediaries (‘QI’) and non-qualified intermediaries (‘NQI’).

A more detailed analysis follows.

What is a QI?
A QI is a foreign financial institution that has entered into a withholding agreement with the IRS under which it agrees to:

• Collect and retain customer information.
• Provide summary information to the IRS and the US payor (e.g. withholding agent).
• Disclose US non-exempt customers (such as individuals, partnerships).
• Submit to a required external audit on a periodic basis.

Why opt for QI status?
Much of the complexity and stringent documentation requirements under the new regulations can be avoided by entering into a QI agreement with the IRS. For example, an Irish QI can typically rely on Ireland’s ‘know your customer’ rules (essentially account opening procedures under the Criminal Justice Act 1994) to identify residency rather than seeking the completion of IRS mandated forms such as a W-8BEN. Ireland’s KYC rules have been approved by the IRS and are outlined in the ‘Ireland’ attachment to the QI agreement.

A QI should not be required to disclose its non-US customers to the IRS or to the US withholding agent by pooling its customers in categories based on withholding rates and types of income. Under the terms of its QI agreement, if it obtains and retains the appropriate documentation on file, then summary information can be provided and there is no requirement to disclose the identity of the beneficial owners.

What are the alternatives? NQI?
In the absence of becoming a QI, an intermediary automatically defaults to NQI status from January 2001. It must disclose details of EACH beneficial owner of the US stocks etc. to the US withholding agent, who in turn is obliged to report to the IRS. If details aren’t disclosed to the withholding agent, they must be disclosed directly to the IRS or serious penalties will be imposed. Non-disclosure is not an option. These requirements are not only onerous but the need to disclose beneficial owner identity is in conflict with bank secrecy rules. The IRS view, however, seems to be that the NQI must be prepared to abide by the new withholding regulations or advise any client that doesn’t want to be disclosed to dispose of their US investments (their primary aim is to ‘flush out’ US non-exempt customers investing through non-US intermediaries). To put it another way, unless QI status is obtained, beneficial owner disclosure is a price that must be paid for investing in the US markets.

Is QI the way to go? If so, how is it obtained?
Each intermediary needs to examine its customer base and determine whether QI status is desirable in light of number of affected customers etc.. If not, they then need to decide whether NQI is feasible for them or whether they should stop acting for (US or non-US) clients with US investments. If they wish to become a QI, an application to the IRS to cover Ireland and, if appropriate, foreign branches/subsidiaries worldwide (assuming their KYC rules have been agreed by the IRS) is the next step. Certain information/documentation must accompany this application, such as:

• Examples of account opening documentation;
• Description of applicant’s business (e.g. stockbroker, asset manager, investment manager etc.);
• General description of type and number of account holders with US assets, as well as estimated value; and
• Country of operation

Once the application has been submitted (and assuming all is in order), the IRS issue two copies of the agreement to the applicant for signature. The agreement is long (over 60 pages) and quite complex but is in a standard (model) format for all applicants. On receipt of a signed agreement, a reference number is issued to the QI (known as a QI-EIN) and this must be used on all returns filed with the US withholding agent or the IRS.

Ongoing return obligations and an audit?
Very briefly, certain summary documentation must be filed with the IRS and the US withholding agent on an annual basis. The QI reporting obligations are far less onerous than those for NQIs. A comprehensive analysis of these is beyond the scope of this article - summary flow charts are available if required.

Broadly speaking, the US withholding agent is not only required to apply the correct rate of withholding and remit the funds to the IRS but must also send periodic information reports. Failure to comply means they are liable for the tax, as well as punitive interest and penalties. It is in their interests to ensure compliance with the new rules and experience to date suggests they will be applying them strictly in their dealings with intermediaries.

An external audit is required under the QI agreement after Years 2 and 5 to verify compliance with the terms thereof. The external auditor must issue a report on its findings to the IRS.

Are the new rules effective now?
They are. It should be noted, however, that the IRS issued a Notice in December 2000 outlining transitional guidance for QIs. This includes analysis of how those applicants who did not have agreements in place by 31 December (and who currently have ‘pending’ QI status) can represent themselves to US withholding agents pending signature of the agreement. It also refers to a transition period for obtaining customer documentation (e.g. copy passport) - the necessary documents must be on file in time for the first audit (at the end of Year 2) and, if substantial compliance with the agreement is reported, the IRS will not request the auditor to examine Year 1. Thus, although there is some time to ensure compliance with the documentation terms of the QI agreement, the IRS have indicated that adverse findings in the first audit will expose the QI to full interest and penalties.

Summarise the benefits of QI status?
Broadly, they are as follows:

• Avoids decreased investor cashflow - e.g. 30 per cent withholding rate rather than 15 per cent ‘treaty’ rate applied.
• Simplifies verification of residence by relying on ‘know your customer’ rules.
• Seeks to ensure customer retention.
• Avoids disclosing non-US customers to US withholding agents (possibly competitors) and the IRS.
• Mitigates bank secrecy concerns due to sheltering of customer names (except for US non-exempt account holders) by pooling their investments.
• Eliminates re-certification of IRS mandated forms from non-US investors.
• Avoids potential requirement for a customer to file a US tax return to obtain a refund of ‘excess’ tax withheld.
• Reduces likelihood that US withholding agents will charge higher fees to process payments due to additional reporting requirements.

Given the benefits of obtaining QI status, a number of Irish financial institutions have applied for QI status during 2000. They are now well-placed to serve customers investing in the US markets and have a competitive advantage over competitors who have not obtained QI status.

So this really is a big issue?
To put it in perspective, Switzerland (long recognised as a bastion of banking secrecy) has huge numbers of QI applicants and a recent Financial Times headline (to an article dealing with QI) read ‘Luxembourg bows to US on banking secrecy’. They, and a growing number of other countries, realise the need to comply with these rules if they wish to continue investing in the US markets on behalf of their customers. Many of our clients (in Ireland and globally) have already devoted significant resources, monetary and personnel, to address the impact of the new rules as they realise the serious implications for their business of not doing so.

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