While everyone is still running around worrying about FATCA and its children, CRS and AEoI, the US Chapter 3 tax regulations still need to be handled. Despite it being 14 years since these regulations came in, problems keep coming out of the woodwork. The latest, ironically, has come to light as a direct result of FATCA.

Under FATCA all financial intermediaries globally are being forced to document their Chapter 4 (FATCA) status by their upstream counter-parties (QIs or US Withholding agents). However, the form they are requesting, one of the W-8 series of US tax forms, also has a Chapter 3 purpose. Under the pressure of the Chapter 4 anti tax evasion rules, these firms are applying for GIINs (Global Intermediary Identification Numbers). The key word here is ‘Intermediary’. However, it is emerging that these financial firms are getting GIINs to certify that they are an intermediary under IRC Chapter 4, then realising that their previous W-8 submission to their counter-party was a W-8BEN, which certifies that they were a beneficial owner under IRC Chapter 3. Big problem.

Choosing the Wrong W-8 Form

Why would financial intermediaries have certified with a BEN when they were clearly not beneficial owners? There are two possibilities.

The first is ignorance: they may just not have been aware. That’s not uncommon and the W-8 series was already complex enough before it was re-tooled to handle Chapter 3 and Chapter 4 issues together.

The second and more serious cause is abuse of the regulations. I’ve now been told anecdotally quite a number of times in my travels that upstream counter-parties preferred a W-8BEN. The reason why this might happen is clear: if you’re dealing with a client and they give you a W-8BEN, the consequential disclosure, withholding and reporting obligations pretty much disappear. You just made your job much easier. The upstream party is essentially leveraging the probable ignorance of its customers. Since the regulations are cascade in nature, there’s also a benefit for the presenter of the W-8BEN too. Pretending (or as the IRS would probably say ‘falsely claiming’) to be a beneficial owner via a W-8BEN means no one (particularly the IRS) is looking for any downstream reporting from you. In other words, the chain of connectivity in US tax reporting can be evaded simply by the presentation of the wrong W-8 form. Ironically, you might even get tax relief if you’re in a country that has a double tax treaty with the US, even though its your clients that might have the entitlement not you.

Now, if any of this occurred, both parties have big problems. Whether or not the upstream party knowingly transgressed and asked for or suggested a W-8BEN when it should have left the matter to its client, is just the first problem. The second problem is one of validation. When the upstream party eventually received this W-8BEN, it had an obligation to validate the form. That includes an obligation to apply ‘reason to know’ and ‘actual knowledge’ rules. Application of those rules, if it had been done, should have led to a rejection of the form as the recipient of the form would clearly have had at least good reason to know, if not actual knowledge, that their client was an intermediary and not a beneficial owner. If the upstream firm then granted treaty benefits they would also have broken the withholding rules because there may have been underlying beneficial owners not entitled to receive such benefits.

So, it’s not just that a mistake might have been made and someone accidentally gave the wrong direction to a client. That would then have to have been compounded by a failure in the validation process by someone else when the form was received and finally potentially the wrong tax rate being applied. A lot of consequences flow from giving the wrong form and from taking the wrong form. For the firm that completed the form, well, ignorance is not bliss. The signature panel on the W-8 has some text below it along the lines of ‘signed under penalties of perjury…’ This means that, however you came into the position of filling in a W-8 and giving it to your upstream counter-party, you are on the hook for it being the correct form and the consequences of any false statement you might have made.

FATCA to the Rescue?

The rather useful but unintended consequence of FATCA has therefore been that what was going on before is now having to be reversed precisely because the W-8 forms are being used for both Chapter 3 and Chapter 4 purposes. You can hardly submit a W-8BEN to counter-party with a GIIN on it. Firstly, there’s nowhere on the form to put a GIIN, and secondly the two are for the most part mutually exclusive so even the most cursory validation process would reject the form.

Who’s Affected?

The most common subjects of this issue are non-qualified intermediaries – that is any financial institution outside the USA, which has not signed a QI agreement with the IRS. Having a GIIN is not the same thing. The simple reason being that a QI, by definition, has demonstrated a greater level of awareness of the regulations and is subject to them both by regulation and by a specific commercial QI contract with the IRS. So, its less likely that a QI would get caught by this. However, there are only around 6,500 QIs in the world while there are estimated to be over 45,000 NQIs. NQIs, on the other hand, have less awareness of the fine detail.

The problem this is giving all these NQIs, apart from the technical breach of the regulations, is that they are now realising that, as intermediaries, they are hit by reporting obligations of their own in Chapter 3 as a result of having disclosed a GIIN in Chapter 4. As this is occurring predominantly in the broker community as opposed to the custodial community, those who have a large exposure to retail clients have the biggest problems. That’s because the reporting obligations on NQIs is at beneficial owner level. So lots of forms due to the IRS, lots of forms due to beneficial owners, and a tax return due to the IRS to top it off.

Options for NQIs

As I said, I’m coming across lots of circumstances where NQI’s are rapidly trying to remediate this material mismatch. Whether or not the IRS has the tools, the resources or the will to go after the financial institutions in these circumstances is debatable. History would indicate not. The issue for the NQIs is really that if they retain NQI status, they will have a beneficial owner level of reporting to understand and handle. If they become QIs (assuming they can become QIs in their jurisdiction), their reporting obligations might be simpler, but their obligations overall are more complex and subject to much closer scrutiny, control and penalties. Do NQIs understand this? The simple answer in my experience is – no.

Image Credit: Eden, Janine and Jim