The 2023 Qualified Intermediary Agreement: broader scope of application and additional requirements

Published on 13 December 2022, the 2023 Qualified Intermediary (QI) Agreement, known as the Rev. Proc. 2022-43, was entered into by the Internal Revenue Service (IRS) and eligible entities as per the corresponding regulations, including foreign financial institutions, foreign clearing organizations, and foreign branches of U.S. financial institutions and clearing organizations. It took effect on 1 January 2023 and brings significant changes for financial institutions acting as QIs. With a short implementation period, these institutions must act quickly to assess the impact of the new agreement on their operations, including changes to documentation, reporting and compliance processes.

Changes mainly apply to QIs who transfer an interest in a Publicly Traded Partnership (PTP) or accept distributions from a PTP on behalf of account holders. Additionally, the 2023 QI Agreement allows specific foreign individuals to operate as Qualified Derivatives Dealers (QDDs) and take on primary withholding and reporting duties for all dividend-equivalent payments they make.

Overview of the QI regime and its latest evolutions

The QI regime facilitates the taxation and reporting of US income (such as dividends and financial instrument coupons) acquired by any beneficial owner via a non-US intermediary. The regime attempts to establish a straightforward mechanism for managing US withholding taxes for all non-US intermediaries that sign a QI Agreement with the Internal Revenue Service for the US federal government (IRS).

Every QI has a duty to gather its clients' supporting paperwork, classify them using this information, and then apply the appropriate taxation based on the determined tax residence and tax status. By respecting these procedures and other strict documentation obligations, the QI’s clients may be eligible for a lower rate under the double taxation Treaty between the US and the countries where they are a tax resident.

The QI Agreement and the QI regime were first implemented on 1 January 2001 and remained largely unchanged until 2014, when the rules were updated to include requirements of a major regulation: the Foreign Account Tax Compliance Act (FATCA).

In 2017, another updated agreement was released, in which it was established that QIs needed to design and run an internal compliance process and submit reports for external review. It also allowed QIs to assume primary withholding responsibilities under Chapter 3 (non-US resident withholding) and Chapter 4 (FATCA withholding) of the Internal Revenue Code (IRC). In this 2017 version, QIs were not able to act as a QI for PTP distributions received on behalf of another account holder that are subject to IRC Section 1446(a) withholding tax.

This 2017 QI Agreement expired in 2022 and was replaced by the new one in 2023.

What are the changes brought by the 2023 QI Agreement?

The 2023 QI Agreement includes new rules aiming to promote more efficient and secure communication between QIs and the IRS. Main features of the agreement are that QIs have to have in place and maintain policies and procedures to ensure compliance with anti-money laundering laws and regulations, including know-your-customer and beneficial ownership identification requirements. The 2023 QI Agreement also makes some modifications to the due diligence procedures that QIs must follow, such as incorporating a requirement to obtain self-certifications and an updated list of acceptable documentation, to ensure that QIs can properly identify their account holders and certify their tax residency and status to the IRS.

In detail, main changes include:

• The requirement to collect US Tax Identification Numbers: The 2023 QI Agreement now requires QIs to get US Tax Identification Numbers (TINs) from their foreign account holders who receive Publicly Traded Partnership (PTP) distributions or amounts realized in order to be considered valid for Sections 1446(a) and (f) of the IRC.

In anticipation of potential difficulties that QIs may generally encounter in obtaining US TINs from all their account holders holding PTP interests, the 2023 QI Agreement includes rules for collecting these TINs. When QIs follow these rules, they are considered to have done their best to obtain TINs. However, QIs still need to collect valid documentation including the TIN to benefit from reduced withholding tax under Section 1446(a) or (f) based on the account holder's status for any year.

• Updated documentation requirements for disclosing QIs: In the Notice IRS 2022-23, it was proposed that a QI must – when acting as a disclosing QI for a payment of a PTP distribution or amount realized from the sale of a PTP interest – act as a disclosing QI for the entire amount of the payment. The 2023 QI Agreement incorporated this requirement. However, QIs need to provide valid documentation, including a US TIN, to the withholding agent to be able to act as a disclosing QI for any account holder receiving the payment.
   

The 2023 QI Agreement also clarifies that a disclosing QI must provide additional payee documentation to the withholding agent, Additional requested information includes for example Form W-9 and TIN.

• New reporting and certification requirements: The 2023 QI Agreement requires Qualified Derivatives Dealers (QDDs) to take on primary responsibilities for withholding and reporting taxes, filing form 1099 and assume backup withholding responsibility under Section 3406 for transactions linked to US equity securities falling under Section 871(m) of the IRC.
   

In addition, QIs that are QDDs or have branches that are QDDs must as of now file 1) Form 1120 if it is a domestic corporation, 2) Form 1120-F if it is a foreign corporation, or 3) Form 1065 if it is a partnership. QDD Partnerships must also file Forms 1042-S for any amounts under Section 3.09 of the 2023 QI Agreement allocated to foreign partners.

To be compliant with the requirements of the new agreement, a QDD must certify, as part of its periodic certification process, that it made a good faith effort to comply with the Section 871(m) regulations and relevant provisions of the 2023 QI Agreement. As a reminder, a QDD is not subject to a periodic review for calendar years 2023 and 2024 with respect to its QDD activities. They must however disclose dividends earned as an equity derivatives dealer on its withholding statement for the calendar years 2023 and 2024.

Other changes include new rules for Chapter 3 withholding rate pools, adjustments for excessive withholding, and changes to how joint accounts are treated and certified under Chapter 4.

What does it mean for Qualified Intermediaries?

While most of the changes were already proposed in IRS Notice 2022-23, the final 2023 QI Agreement was published less than one month before go-live. As a result, significant efforts will be required from QIs to review their compliance programs and periodic review processes to ensure compliance in a timely manner.

As a result, it is essential more than ever for QIs to have a strong compliance infrastructure in place, effective control and oversight mechanisms and to partner with a trusted tax advisor to navigate the changes and ensure a smooth implementation.

This article was published in AGEFI.