This month we’ve tapped subject matter expert Ross McGill (a friend to ViewTrade who has been at the pulse of global financial markets for decades) to share his insights on what it means to be a qualified intermediary (QI) versus a non-qualified intermediary (NQI).
Mr. McGill is Chairman and co-founder of TConsult, a UK based consulting and regulatory services firm with clients in fifteen countries. McGill literally wrote the book on US withholding tax now in its second edition. Mr. McGill sits on several international committees as a tax specialist, notably ISO20022 standards groups on corporate actions, proxy voting and funds management. He has also been an expert witness and was a contributor to the European Commission’s work on the removal of barriers to the free movement of capital. Mr. McGill is a well-known and respected subject matter expert.
What are the Benefits of Being a QI and Challenges of Being an NQI?
I’m often asked these questions and there are several ways to answer them, most of which start with ‘it depends’. There are three key issues to consider in order to make a decision and, once you take that decision, two issues you need to act on as a QI.
In 2009, the US government made it clear that non-US financial firms that provide access to the US securities market and that did not adopt QI status would be “deemed to be facilitating tax evasion”. If you receive US sourced income e.g. dividends or portfolio interest, on behalf of someone else, you are, by the US definition an intermediary, a withholding agent and, by default, a non-qualified intermediary (NQI). So, if you value your reputation, it’s a bit of a no-brainer that you should consider QI status. If you have relationships with financial counterparties you may have already encountered this effect. Most financial firms will not do business with NQIs or if they do, they place severe restrictions on them. Many firms are even starting to use QI status as a competitive advantage.
It doesn’t matter whether you’re a QI or an NQI, once you start receiving US sourced income, you automatically become subject to regulations in the US Income Tax Code, particularly Chapter 3, but you might also be exposed to Chapter 1 Section 871(m), Chapter 4, Chapter 31 and Chapter 61 – it depends on who your customers are and what type of business you’re running (brokerage, custody, securities lending, derivatives trading – all these have an effect). In general, the Chapter 3 regulations require any non-US intermediary to report payments of US sourced income they make to their customers – to the IRS on a form 1042-S, then also file a US tax return (1042). The big difference is that an NQI, because they aren’t trusted, must file a separate report for each and every customer. Think about that for a moment. Every year, you’ll be sending a data file to the US Government that includes personal information about your non-US customers – name, account number, date of birth, amount of income, tax withheld. You’ll have to provide your customer with a copy of their 1042-S report too.
The US has 68 tax treaties with other countries. These can, when applied, reduce the tax burden on dividends and interest from the statutory 30% down to 25%, 15%, 10% and even 0%. The problem is that an NQI cannot grant tax treaty benefits to a customer UNLESS they disclose that customer to a QI. That would mean disclosing your customers to a competitor in order to get your customer a tax benefit. Not many firms are happy to tell their competitors who their customers are, so most do not disclose them and, as a result, 30% Non-Resident Alien (NRA) tax is withheld and the customer loses out on any tax benefit. A QI on the other hand can grant treaty benefits, as long as it has properly validated documentation in its possession on the pay-date that proves that its customers are eligible for a lower rate. This is most frequently achieved with a US form W-8 of which there are five types. Two, the W-8BEN and W-8BEN-E, used by individuals and entities respectively, have a special section for claiming treaty benefits on the form – but here’s the rub. In Asia, the fail rate is over 70%. In Europe its between 13% and 30% and in South America its around 35%. So, where an NQI’s challenge is that it can’t grant treaty benefits without disclosing its customers to a competitor, a QI’s challenge is making sure it is able to robustly and properly validate these forms in order to correctly grant a tax benefit. If it does not and it grants a lower rate anyway, it could be guilty of under-withholding tax – and the IRS is NOT happy about that.
Operations and compliance
So, reputation, data privacy and tax benefits are the three main issues you need to think about when considering QI status. Once you’ve made that decision in principle, you need to think about what will happen after you become a QI. There are two broad issues to think about – operations i.e. how do you meet your QI obligations in a practical sense; and compliance i.e. how do you prove to the IRS that you are meeting your obligations in the contract you signed with them.
I’ve already noted that an NQI’s challenge is that it has to disclose personal data of its customers to a competitor if it wants to get tax benefits for them and it will always have to disclose those customers to the US government every year anyway or face serious financial penalties of up to US$6m. But an NQI does not sign a QI agreement so, other than these two really quite major issues, NQIs don’t need to prove anything to the IRS because they aren’t trusted to start with. QIs on the other hand are signing a 120+ page contract with the US government. It’s this instrument that gives them the benefits I’ve talked about, but it’s also this instrument that contains the governance, control and oversight rules that QIs have, which NQIs don’t.
The operational issues can be addressed because they are focussed on deciding between operational options for documenting customers, withholding tax, depositing tax and information reporting. That’s an annual cycle that just repeats once you’ve set it up. For each area however, there are some options available that can significantly reduce cost and risk depending on the nature and scale of your exposure to the US market.
The compliance issues are centred on a three year cycle in which someone in the firm, appointed as Responsible Officer, for QI status, must certify to the IRS that the firm has effective controls and disclose to the IRS if there have been any breaches that would be material failures or events of default. To do that, amongst other things, you might, if you don’t qualify for an exemption, have to conduct an independent audit of your compliance. This all takes effort to do, which is a challenge, but should always be considered in context to the relative importance of the US securities market to your business.
So, in summary, if you access the US securities market, your reputation is best served by being a QI and you could use that status for your competitive advantage. As a QI you can grant tax treaty benefits to customers that NQIs cannot. As a QI you get to protect the identity of your direct clients that, as an NQI you do not.
Now, it is true that the scale of your exposure to the US market will make a difference. In other words, the cost of meeting those operational and compliance rules could be higher than you expect. The IRS does give some leeway to make it easier for small QIs, but you still need to factor in a ‘cost of doing business’ when you think about the US market.
Now, not everyone can tick all those boxes but that’s not necessary for QI status to still be a no brainer. For example, if you’re in a country that has no tax treaty with the US and most of your customers are domestic residents, then you could still be a QI, but you won’t be able to grant treaty benefits to most of your clients anyway, because they won’t be eligible. The reputational and data privacy issues then become more important.
We’ve thought a lot about this for twenty years of being involved with the US tax rules and with the clients we have in fifteen countries. That’s why we put all our skills and knowledge online into a Tax Compliance Toolkit platform (TCT). TCT contains a wide range of standard QI project templates, a knowledge base, reporting and document validation tools as well as training videos and management dashboards to help QIs meet their obligations and have effective controls. If you’re interested, get in touch with your ViewTrade relationship manager and they’ll put you in touch with us.
Please note: The views, information and opinions expressed are those of Ross McGill and do not necessarily represent those of ViewTrade and its employees. The purpose of this information is to educate and inform. This blog post does not constitute professional advice or services.