By now you should be familiar with a form W-8BEN-E. You might have even filled one out in the past. But when working with financial institutions, we’ve noticed something off. There is a potential misuse of the W-8BEN-E by non-qualified intermediaries (or NQIs), where they are using (or being encouraged to use) the BEN-E to get around the US tax regulations and gain treaty benefits without disclosure, allowing them to avoid their reporting obligations. That doesn’t seem right – or does it?

The Argument…

When we speak to institutions that are doing this (because there are a few!) we always hear the same arguments. It goes something like this:

“We are organised and incorporated in our jurisdiction which happens to have a double tax treaty with the US. We also happen to be a broker, and we take title to our client’s assets and hold them in “street name” with our counterparties. So, the self-certification form we should use is the W-8BEN-E. That also means that we can claim tax treaty benefits and pass those on to our clients without having to do any reporting to the IRS.”

Or, if you want a real scare, we’ve also heard: “…our counterparty told us that if we want to make life easy, we should present them with a W-8BEN-E”.

Now that is bad! In this situation, the counterparty won’t produce a recipient copy 1042-S for the client, because it was pooled with its other direct entity clients. This is what makes it easy for them. The financial institution itself is still benefiting from treaty rates, but does no reporting because the IRS is unaware that a financial institution is the recipient.

On the surface, these look like perfect ways to get around the US withholding tax regulations, and we’ve seen it happen a fair few times. The problem is, both of these arguments are wrong.

What’s Wrong?

The argument falls down on three levels, so let’s tackle each level one at a time.

First, all financial institutions are incorporated somewhere. It’s not really about what you are that counts, but more how you act. If you act on behalf of your clients to buy or sell US securities, or if you offer safe-keeping services as a custodian, then you are, by definition, an intermediary. Yes, even though you’re a corporation. The fact that you take the title to those assets and hold them in a street name doesn’t make you the beneficial owner of the income from those assets. To find out more about that, check out my blog on title vs beneficial ownership.

Secondly, if you present a W-8BEN-E to another financial institution when you are knowingly acting on behalf of your clients, the receiving institution is bound by regulation to:

1. Validate that W-8 is the correct form and that it’s completed, signed and dated correctly;
2. Check the Form against KYC, and;

• Check that there is no other ‘reason to know’ that for form is invalid,

You are guaranteed to get caught by at least two of those tests if the institution is doing its job properly. For example, the ‘reason to know’ test would mean that they visit your website, where they would very quickly find out that you’re offering services to clients, and so you might not be the true beneficial owner of the income. This would make the W-8BEN-E unreliable, because it’s probably the wrong form. If that institution is a QI and accepts the form without doing that check, they would be breaching their contract with the IRS. So, it’s not just your institution you’re putting at risk if you’re caught – it’s your counterparty as well.

The third reason is nice and simple. Presenting a W-8BEN-E in these circumstances means you’d be making a false statement under penalty of perjury in US law. This exposes both you as the signer and your firm to some very heavy penalties.

Is There a Time This Would Work?

There’s only one reason that a financial institution would present a W-8BEN-E to another institution, and that’s if they engage in proprietary trading using their own money. That would, as a matter of best practice if not regulation, require the segregation of assets. So, if a financial institution has proprietary assets, then it should hold them in a separate account from client assets. Now the accounts in which you’re holding the client assets (which may be rate pooled) would be documented with a W-8IMY, while the accounts containing your proprietary assets would be documented with a W-8BEN-E on which the corporation could claim a tax treaty benefit.

You might think this is quite a rare occurrence – but you would be amazed at just how many trusts fall foul of this issue. Only some trusts can complete a W-8BEN-E, while others must complete a W-8IMY because they’re treated as flow-through entities.

So, if you’re thinking that you might be able to get away with submitting a W-8BEN-E to avoid US reporting and get treaty benefits without having to do any work, think again! This is just one of the ways you can get caught, and there’s a very long list of others! And if you’re a financial institution on the receiving end of a W-8BEN-E, remember to do all of your checks. It’s just not worth the risk skipping them.

If you would like to know more about navigating the choppy waters of US Withholding Tax regulations, just get in touch with TConsult today, and one of our subject matter experts will be happy to help.