TRACE: The next big tax thing

Oct 2, 20190 comments

Since Finland announced that it would be the first country to adopt the OECD’s The Tax Relief and Compliance Enhancement (TRACE) IP from 1st January 2021, there has been much excitement in the marketplace about the new regime and the opportunity it presents for financial institutions operating in global markets.

 

TRACE is functionally very similar to the US Qualified Intermediary (QI) and the Irish QI regimes and are all to do with the correct taxation of cross border income at source. They are not really about anti-tax evasion as some may think. We expect the early adopters of the TRACE IP within the Finnish market to be existing QIs. In this post, we explore the similarities and highlight why a QI should consider becoming an Authorised Intermediary (AI) within TRACE to maximise the return on their investment in QI compliance.

 

Becoming an Authorised Intermediary

 

The basis for both the QI regulations and TRACE framework is a contract or agreement with source country. To be accepted, the prospective QI/AI needs to be in a Know Your Customer (KYC) approved jurisdiction, and comply with relevant anti-tax evasion frameworks, such as FATCA, Common Reporting Standard (CRS) and DAC2.

 

A QI that applies to become an AI will immediately see a number of similarities in the obligations that need to be met. The parallels can be seen at each of the three key stages: documentation, withholding and reporting. These are the foundations that financial institutions (FI) need to get right if they are to be compliant and are often considered to be the three pillars of good compliance and effective governance.

 

If we look at each of the three pillars and delve deeper, we find further resemblances in how each regime operates in practice:

 

Documentation

 

In both regimes, beneficial owners need to document themselves and if they are entitled to a reduced rate of withholding, can claim treaty benefit if they wish. This will typically be done by providing the intermediary with a self-certification form – usually a W-8 form for US investments and the QI regulations, or an Investor Self Declaration (ISD) under TRACE allowing AIs the ability to grant treaty benefits without procuring a certificate of residence. These self-certification forms should be supported by KYC and Anti Money Laundering (AML) evidence.

 

Once validated, these forms are usually reliable for a limited period before a new form should be obtained from the beneficial owner, unless the client has a change of circumstance. The QI and TRACE regimes only diverge on the length of the validity period (three years for QI vs five years for TRACE).

 

Where the ultimate beneficial owner is an indirect client, both regimes have disclosure mechanisms that govern how documentation should be handled by the various intermediaries in the chain. This allows financial institutions that are not QIs or AIs to access relief at source for their underlying clients, via an upstream QI or AI. In the QI regime these financial institutions are known as non-qualified intermediaries (NQIs) and in TRACE they are known contractual intermediaries (CI).

 

In both regimes, an NQI and a CI should disclose their clients by providing the documentation and withholding statements to their upstream QI or AI, in order for them to document and withhold at the correct rate. An NQI and CI that does not disclose to its upstream QI or AI cannot access relief at source at all.

 

Withholding

 

The way that financial institutions structure their withholding tax rate pools with their upstream counterparty is essentially the same in these two regimes. FIs are able to use omnibus accounts based on the applicable tax rate or a segregated account structure and/or a combination of both.

 

In both regimes, valid documentation allows the QI or AI to withhold at the correct rate on pay-date, be that at the standard default rate or a reduced rate of withholding due to a valid claim of treaty benefits.

 

If, for some reason, there has been over or under withholding, both the QI and TRACE regimes have comparable procedures for QI and AI to remediate over and under withholding.

 

Reporting

 

Each year a QI and AI will be required to report information relating to the income that was paid to the beneficial owner and the withholding amount, to the IRS and source county’s revenue service respectively.  In both instances, the reporting FI is able to do this electronically and if necessary, file amended reporting should an error have occurred.

 

In addition to the information reporting, both the QI and AI are required to file a tax return report (QI) and Year-End summary report (AI) to the IRS and source country’s revenue service respectively.

 

In both the QI and TRACE regimes, there are specific forms that should be completed in order to comply with the reporting obligations.

 

Control and Oversight

 

In order for the documentation, withholding and reporting to come together to form a well-oiled machine, a robust and detailed compliance program is a must have for any financial institution. This should lay out policies and procedures for how the regulations are to be implemented.

 

The key to bringing all this together is a team of people, resources and knowledge. Under the QI regulations, this is headed by a Responsible Officer (RO). Whilst there is no concept of a RO in TRACE, we see no reason why a QI RO should not take the lead on control and oversight issues for TRACE. The QI RO should be the person in the business that has the ability to see and monitor the overall compliance for each regulation, and should therefore be best placed to ensure compliance with TRACE.

 

Should a QI become an AI?

 

As TRACE gains traction, those financial institutions that are already a QI under the US regulations will have an edge over other financial institutions looking to access relief at source in TRACE markets. 

 

QIs should have a strong foundation of appropriate operating procedures and the necessary understanding to implement and meet the TRACE obligations. It therefore makes sense for QIs to analyse emerging TRACE markets and gain a competitive advantage by becoming early adopters in those markets. If you have already done all of that work to become a QI, becoming an AI is a no-brainer!

 

Should you wish to know more, or if you need help to understand your obligations as a QI or AI, please get in touch by emailing info@tconsult-ltd.com.

Author

Stuart Lipo

Stuart Lipo

Subject Matter Expert

Stuart is one of the key researchers and curators of legislation within TConsult Ltd. He was born and educated in South Africa before moving to the UK. Since leaving college Stuart has worked in the financial industry for independent financial advisors. His experience helps TConsult expand our specialisms and industry knowledge. He is the curator of our GATCA Resource Library.

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