M E M O R A N D U M
July 31, 2009
TO: Distribution
FROM: Burt, Staples & Maner LLP
RE: Meeting with IRS on July 30, 2009, to discuss changes to the QI system
BACKGROUND: The IRS met with a limited number of
representatives of the legal and accounting professions on July 30,
2009, to discuss pending legislative and regulatory changes affecting
U.S. withholding taxes, particularly the Qualified Intermediary (“QI”)
program. We summarize below the points potentially of interest to those
following these developments.
LEGISLATIVE PROPOSALS:
The IRS representatives believe that the Obama Administration proposals
will pass by the end of the year. They acknowledged that they were
involved in the drafting of these proposals. If history is any guide,
the IRS will remain a key technical resource to both the Administration
and Congress. Industry groups and individual financial institutions
should take note of this involvement in fashioning any effort to educate
the Administration and Congress about their concerns with the proposals.
We summarize some of the key points below on the proposals but note that
the conversation was truncated and incomplete due to time restraints.
U.S. Beneficial Owner Proposal: The
current proposal would require a withholding agent to withhold 30% on
U.S. source income paid to a foreign entity if that entity does not
supply the withholding agent with “beneficial owner” information. The
IRS appeared open to discussing: (1) whether it is desirable to alter
the longstanding concept of “beneficial ownership” for tax purposes; and
(2) whether AML documentation requirements and concepts differ too much
from country to country to be useful and instead should be replaced with
new tax requirements. The IRS expressed willingness to discuss
alternatives to reach their compliance goal of being able to identify
the U.S. owners of such entities.
Worldwide Form 1099
Reporting: The current proposal would impose on foreign payors
the obligation to report both U.S. and foreign source reportable
payments to any U.S. non-exempt recipient. The IRS was interested in
learning why they are hearing that this proposal would be both expensive
and difficult for non-U.S. payors, particularly QIs, to implement. It
seemed clear that the operational, systemic, and technology issues have
not been well explained to them. However, the IRS was willing to hear
alternative ways for non-U.S. withholding agents to identify U.S.
persons invested in foreign accounts short of requiring them to engage
in full Form 1099 reporting.
Worldwide QIs: The
current proposal authorizes regulations to require that any entity that
signs a QI agreement treat all entities in its worldwide group as “QIs.”
The IRS explained that the goal of this proposal was to prevent QIs from
shifting U.S. persons (particularly those holding only non-U.S.
securities) from QI to NQI entities. (The proposal would also change the
current rule that an “entity” is not a QI but rather designates
particular accounts as “QI accounts” subject to its agreement). The IRS
accepted that this proposal was likely overbroad and too expensive but
wanted alternatives suggested. Some ideas that were discussed included
an annual certification by the QI that other members of its worldwide
group were not “hiding” U.S. people, although the consensus was that
this proposal too would impose significant costs and risks on worldwide
groups with QIs.
ANNOUNCEMENT 2008-09: The bulk of the discussion centered on this announcement but only covered two of its three proposals.
Notice of Material Failure of Internal
Controls: Currently, QI external “audits” are not audits
analogous to those for financial statement purposes, but rather are
limited fact finding exercises conducted under “Agreed Upon Procedures”
(“AUP”). It was clear from the discussion that the IRS believes it is
possible, and desirable, for these checks to incorporate judgment calls
such as identifying what is a “material failure” of internal controls,
or even simply telling the IRS if “anything seems amiss” with an
entity’s QI compliance, even if doing so takes the review beyond the
scope of AUP standards into a “limited attest” standard. The
participants stressed to the IRS that QI external audits can evolve in
only one of two ways – either QIs will be required to undergo financial
statement-type audits with the attendant increase in costs and risks, or
the IRS will need to define what they mean by a “material failure” and
have QIs themselves attest that no such failures have occurred. One
recommendation was made that the annual attestation by the QI could be a
broader explanation of controls and procedures in place, so that the IRS
itself could make a determination of whether existing “Phase II” AUP
steps need to be incorporated into Phase I of the QI’s review.
Participation of U.S. Audit Firm in QI External Audit:
The IRS admitted that this proposal was not designed to address any
perceived problems with how non-U.S. auditors have conducted QI external
audits in the past. Instead, the IRS hinted strongly that the reason to
include the involvement of a U.S. audit firm is related to the IRS
desire that QI external audits include “substantive” checks more like
those performed for financial statement audit purposes. In addition, the
IRS wants to have a U.S. party liable for any failure to “root out”
problems in the course of these “audits” which, again, is a financial
statement audit concept and not an AUP concept. The IRS expressed a
willingness to consider alternatives – perhaps just requiring a
centrally controlled audit process in multinational audit firms, or
requiring non-U.S. affiliates to demonstrate competency to conduct the
checks.
QI DOCUMENTATION AND REPORTING FAILURES AND PENALTY
IMPOSITION: The IRS QI team in New York also made a brief
presentation. Of most note was their contention that QI documentation
failures remain significant and will no longer be tolerated since most
QIs have gone through three audit cycles. The IRS stated that anything
beyond a three percent document failure rate was excessive, even if
maximum withholding was applied based on the presumption rules.
Presumably, the IRS would penalize QIs for failing to document their
account holders as required under their agreement. Finally, the IRS
proposed to begin assessing penalties in the 2010 filing season for
information return reporting errors.
CONCLUSION:
We hope that you find the above summary helpful. Please feel free to
contact John Staples at 202-783-1500, Cyrus Daftary at 617-963-3412 or
Roger Cardinal at 617-519-9639 if you would like to discuss any of these
issues in greater detail.