I am coming across an increasing number of financial firms who have NQI status under IRC Chapter 3 withholding tax regulations, who are being told to become QIs by their USWAs.

The QI Myth

There’s no real Chapter 3 logic here that didn’t exist before. In those markets where QIs can exist, there are still large numbers of NQIs whether by choice or just through lack of awareness. The driver, for some obscure reason appears to be FATCA (IRC Chapter 4).

The most common myth that NQIs have historically laboured under is that by not signing to be a QI, they are somehow not affected by IRC Chapter 3 (which has tax return and information reporting obligations). This is of course not true, but I’ve heard it so many times, I actually produced a YouTube video explaining the issue both in English and Mandarin.

QI Status

So I’m rather perplexed by US Withholding agents insisting that their clients become QIs. Its got to the stage where I’m hearing that USWAs won’t open allow accounts to be opened by any financial institution unless they have QI status in Chapter 3. The suggestion to become a QI is all very well, and may be driven by any number of commercial policies. The difficulty is that the recipients of this message appear to be getting no help in understanding what it means to be a QI nor how this status relates to Chapter 4.

The IRS itself learnt the lesson of the period 2001-2012 in that most QIs don’t allocate enough resource, budget and/or don’t have adequate training in place to be able to meet their obligations. This has become clear in the 2014 Revenue Procedures which began the convergence of Chapter 3 and Chapter 4 in which adequacy of resource and training have become explicit parts of the new Periodic Review control and oversight regime.

Tax Regulatory Landscape

We now seem to have a very odd and fragmented US tax regulatory landscape. The US has double tax treaties and so there’s a population of markets which have and don’t have treaties. There’s a population of markets that have KYC rules approved by the IRS (and in which, by definition, there can be QIs). There’s finally a population of markets that have signed IGAs with the US. The problem is that there is only limited overlap between these three populations, converging IRC Chapter 3 and 4 and (ii) signing IGAs that includes the principle of reciprocity. It’s a very confusing landscape. It gets even worse if you overlay the markets that have signed or committed to the OECD model for Automatic Exchange of Information (AEoI) and Common Reporting Standards (CRS).

The Next Step

Back to the QI vs NQI question. In amongst this bewildering regulatory landscape, the small or medium sized FI gets told they have to be a QI. What do they do next? Well, as I’ve found out the hard way, they’re calling me up (which is a good thing!). This is the first time that they find out that, while the application process is relatively simple (and I use the term ‘relatively simple’ with due care), the consequences for the firm can be very ‘significant’. Significance means not just understanding the process elements – due diligence, withholding, reporting and oversight, but also the impacts of the operational issues on them – rate pool accounts, withholding status vs non-withholding and so forth very little of which is being explained at the USWA level.

Don’t get me wrong. I spend a lot of my time helping these people understand these issues with our in-house training courses. I think that some level of guidance at the USWA level that these issues exist, would enhance the reputation and quality of the client relationship leaving people like me to help them fill in the blanks.

The other reason the industry needs to get this message across more clearly to these smaller FIs is that if not, the IRS is going to start receiving a much larger number of inaccurate and/or late tax returns and information reports than they have from their legacy QI population of around 6,500.

There always has been, since 2001, a desire by the IRS to get as many QIs signed up as possible. Indeed, there are those that believe that if the QI regulations had been more widely adopted in the form of QI Agreements, that FATCA may not have been needed. That’s because there are aspects of Chapter 3 (and associated Chapter 61) rules that do attempt to get non-US institutions disclosing US account holders. With only 6,500 QIs out of a de minimis global population of at least 50,000 eligible firms, there’s still a very large population of NQIs out there and most of them are satisfied (again a relative term) to be taxed at 30% and ignore their tax return and reporting obligations. With that level of non-compliance, it’s unsurprising that FATCA came about.

I did a ‘back of envelop’ calculation the other day based on what would happen if the IRS actually did impose the regulatory penalty on every NQI that had failed to file a tax return and information reports since 2001. The penalties alone, assuming there was enough information available to apply the penalty, would, I estimate, be in the region of $85Bn, not including interest. We need to wait and see whether the penalties associated with FATCA can be a more effective tool.

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