I am seeing a rapidly increasing trend in the market. Many US Withholding Agents and quite a few QIs are now insisting that their financial institution clients, who are currently non qualified intermediaries (NQIs), become qualified intermediaries (QIs) in order to do business with them.

While much of this is driven by commercial considerations, particularly in the brokerage community, there now appears to be a significant population of NQIs who had been doing business quite nicely thank you, who are now faced with total exclusion from the US market unless they adopt QI status. So, this is a big deal.

To give you an idea of the context and scale of this issue, the number of QIs today is estimated to be around 7,000. The number of NQIs that would be able to meet the eligibility criteria for QI status is estimated to be at least 50,000 worldwide. I could write at length, but not here, about the reasons why this trend is occurring, the misinformation that’s driving it and the lack of appropriate support or explanation. In this blog, I want to take as my starting point the simple fact that your counterparty has given you an ultimatum: “Become a QI or you can’t have an account with us.”

The elephant has now entered the room. The QI application process itself is relatively simple. It’s a couple of forms and informational attachments. So, NQIs faced with the ultimatum can easily be led to believe that this issue can be solved simply by filling in a few forms and all will be well. This is simply not true.

The underlying reason for the policy is usually that it makes life easier for the requestor. The change from NQI to QI status effectively pushes the operational burden down one level. Now, there’s nothing wrong with commercial expediency per se and I have no problem with NQIs becoming QIs. Much of our business at TConsult is helping NQIs with the QI application process. But we will only do that if we believe that the NQI understands what they are doing, what decisions they need to make, and what obligations they are taking on. We do this via training and consultations prior to the application being filed.

So, we like the fact that NQIs want to become QIs. What we are finding frustrating is the number of these firms who clearly reacted without finding out what the consequences of their actions would be. Also, and somewhat ironically, if more NQIs had become QIs back in 2001, we probably would not have FATCA today. Anyway, better late than never!

So, here’s a little quiz. It’s a quiz designed for NQIs who’ve been told to become QIs. If you can answer these questions (without having to look them up), then you are well enough informed to understand the implications of, and risks associated with, what you are about to do. If you can’t answer these questions (or you don’t understand the question in the first place), then you are likely to be putting your firm at significant risk if you just ‘fill in the forms’.

QUIZ: Do You Know Enough to be a QI?

1. How many types of QI are there?
2. How many pages are there in the QI contract?
3. Is the following statement correct? ‘QIs do not have to disclose their customers to the IRS because QIs report on a pooled basis’.
4. Who reports beneficial owners disclosed to you by NQI customers?
5. What’s the main difference between a 1042 and a 1042-S?
6. How many functional processes is a QI obligated to perform?
7. What does the acronym EFTPS mean?
8. What does the acronym FDAP mean?
9. What are the two main structural methods for processing tax relief?
10. What’s the name for the special rules you have to apply if you cannot associate a payment with valid documentation?

Making the Change

The reality is that there is little or nothing you can do if your upstream counterparty insists that they will only do business with you if you are a QI. The trend is growing, so it’s increasingly unlikely that you will find alternative providers who will accept you in NQI status (although there are happily always some who see these issues as competitive advantage opportunities). But you should not take a ‘knee-jerk’ reaction and just fill in the forms. It’s incumbent on you to make sure you have understood the implications and have made structural and compliance decisions that meet your counterparty’s needs, but more importantly are right for your business too.

What strikes me as odd is that, as more NQIs change to being QIs without the proper research, training and structural considerations, there will be a significant degree of non-compliance which will only become evident three years down the line when responsible officers have to go through their periodic reviews and then make their first ‘certifications of adequate controls’. Any auditor conducting a periodic review of these firms is likely to find that the decision to take on QI status was based on insufficient knowledge and information, leading to a lack of compliance.

Quiz Answers

For those who took the quiz, here are the answers:

1. Two (Withholding and Non Withholding). If you don’t know this, then you also don’t know that a non withholding QI is essentially outsourcing withholding and depositing tax to a third party. You can outsource the responsibility, but you keep the liability if they get it wrong.
2. 108. If you know this, you have an idea how much you are signing up to.
3. No. QIs can only pool ‘direct accounts’. Indirect accounts are separately reported. If you didn’t know this, you’ll probably get your reporting wrong and you’ll get penalised.
4. Yours. If you, as a QI, have NQI customers and they in turn disclose their clients to you (e.g. to obtain tax relief), the reporting obligation flows up to you.
5. A 1042 is a tax return. A 1042-S is an information report. If you got this right, you probably know enough to be aware that these two have to match to within a few dollars AND they have to match to all your upstream counterparty’s reports – otherwise you get a Penalty Notice.
6. Seven. The processes required are: contract (and renewals), document (KYC + W-8), withhold, deposit, report, control (compliance program and responsible officers), oversight (periodic reviews and certifications). If you got this right, then you know that being a QI is not just about filling in a form.
7. Electronic Federal Tax Payment System. QIs are expected to join this system as part of the QI process.
8. Fixed, Determinable, Annual or Periodic. These are the types of US sourced income subject to NRA withholding. If you don’t know this, you’ll probably get your reporting wrong.
9. Withholding Rate Pool accounts and Withholding Rate Pool Statements. The first are omnibus accounts each with comingled assets of underlying beneficial owners all entitled to a single rate of tax. The second is a messaging protocol that allows the use of a single omnibus account.
10. Presumption Rules.

Image Credit: Alberto G