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Introduction:
What The Legislation Does
The
legislation setting up Qualified Intermediary
status is contained in the IRS Tax Code in Section
1.1441-1 through 9. The text of the legislation
can be accessed through links in Annex
I
to this article. It is called 'Requirement for
the deduction and withholding of tax on payments
to foreign persons' because the original purpose
of the legislation was to impose withholding on
payments made from the US to foreign persons or
to US citizens abroad, but as now amended it also
applies to payments of US source income made to
persons outside the US by financial institutions
(called 'withholding agents') whether or not they
are in the US.
The
amended legislation was added to the Tax Code
in April 2000. In the words of the Code, 'It prescribes
procedures to determine whether an amount must
be withheld . . . . and documentation that a withholding
agent may rely upon to determine the status of
a payee or a beneficial owner as a US person or
as a foreign person and other relevant characteristics
of the payee that may affect a withholding agent's
obligation to withhold . . . . Special procedures
regarding payments to foreign persons that act
as intermediaries are also provided.'
There
are exemptions from withholding for, among other
things, income effectively connected with the
conduct of a trade or business in the United States,
and there are provisions dealing with payments
made to 'flow-through' entities (eg entities such
as limited partnerships which have 'checked the
box' and are fiscally transparent as regards US
tax) and with reduced rates of withholding where
tax treaties apply.
There
are exemptions for foreign governments, some international
organizations, foreign central banks and the Bank
for International Settlements, and there are rules
for dealing with payments made to organisations
which are 'tax-exempt' in the jurisdiction concerned.
A
withholding agent must withhold 30% of any relevant
payment made to a foreign person unless it has
documentation showing that the payee is a US person
or is entitled to a reduced rate of withholding.
However, a withholding agent need not withhold
if the payee is a qualified intermediary
(ie another financial institution that has qualified
under this legislation), is a US branch of a foreign
person or is otherwise exempt.
Normally
the documentation that will absolve a withholding
agent from withholding is a Form W-9 (indicating
US status of the payee). Form W-8 or a Form 8233
(indicating foreign status of the payee or beneficial
owner) may allow withholding at a reduced rate
under an appropriate tax treaty.
The
legislation introduces for the first time the
status of qualified intermediary, which
can be applied for by a financial institution
if it is in a country which has been approved
by the IRS as having acceptable 'know-your-customer'
rules. A country wishing to apply for approval
has to answer questions under 18 headings; once
approved, its applicable legislation and regulation
is detailed in an 'attachment'. Annex
II to this article consists of a list of approved
countries for which an attachment exists - by
clicking on a country you can see the attachment
in each case. The IRS is developing standardised
'attachments' but these are not yet available.
In
order to become a qualified intermediary
an institution in an approved country must enter
into an Qualified Intermediary Withholding Agreement
with the IRS. This 60-page document forms part
of Revenue
Procedure 2000-12,
which also contains a list of the 18 questions
needing to be answered by countries. The agreement
imposes very complex documentary obligations on
the institution concerned, but allows it to maintain
confidentiality for non-US clients. The agreement
lasts for six years, and there are external audits
of adherence to the terms of the Agreement in
the second and fifth years. An institution in
an approved country which does not become a qualified
intermediary, or one in an unapproved country,
must disclose details of all its clients to the
IRS if it wishes to avoid having to charge (or
being charged) full 30% withholding tax on payments
of US-source income.
The
IRS permits a branch of a qualified intermediary
in another, unapproved country to share in its
parent's qualified regime, providing it is subject
to the supervisory regime applying in the parent's
home country. This is explained in IRS
Announcement 2000-48. If the IRS classifies
a country as a 'tax haven' or a 'bank secrecy
jurisdiction', branches of intermediaries having
obtained qualification will be allowed to serve
out their 6 years; but the IRS will apply stiffer
audit procedures and default sanctions to branches
which qualify after such a classification and
to renewal situations.
In
practice life would be very difficult for any
financial institution which did not either sign
an Agreement with the IRS, or conform to full
information disclosure about its clients. Leaving
aside the possibility of sanctions which could
be applied by the US, there would be disadvantages
for legitimate clients who may be denied access
to reduced treaty rates of withholding tax or
who may have to use cumbersome routes to reclaim
overpaid tax. US citizens in particular would
find it very difficult in future to receive US-source
income without paying the tax on it: while payments
emanating directly from the US have always been
subject to tax, many types of deemed US-source
income (eg sale of securities through a foreign
broker or overseas income from trust and investment
funds) might previously have by-passed the official
withholding system, leaving payment of tax to
the conscience of the tax-payer.
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