Recently we came across a rather interesting situation. We were approached by a non-qualified intermediary (or NQI) who claimed they had no reporting obligation because their upstream counterparty had already reported the payments they received. So they were under the impression that they didn’t have to file 1042-S or 1042 forms.

Now, some of this is true, and some of it isn’t. So, we wanted to take the time to clear it up.

What is the Multiple Withholding Agent Rule?

The multiple withholding agent rules says that, if another withholding agent withholds correctly and reports the payment to the same recipients as the other withholding agent would have done, then the other withholding agent doesn’t have to report their income or the tax withheld. The specific wording of this from the IRS is:

“A withholding agent is not required to file Form 1042-S only if a return is filed by another withholding agent reporting the same amount to the same recipient, and the other agent has withheld correctly.’

The key part of this rule to pay attention to is the words ‘same recipient’. It’s all about disclosure. If an NQI has disclosed its customers to a QI, then the QI will report each beneficial owner directly to the IRS and issue a recipient copy to the beneficial owner. That means the QI has performed the withholding, and also reported the recipient in the same way that the NQI would have done if they hadn’t disclosed their client. So the NQI has no filing obligation with respect to the disclosed recipients, and no 1042 tax return obligation if all recipients were disclosed.

So What’s the Exception?

The story is different for an NQI that doesn’t disclose its clients (also known as a non-disclosing ND-NQI). The IRS wrote the regulations on the assumption that all NQIs would disclose their clients to a QI or a US Withholding Agent (USWA), but the reality isn’t quite that simple. Most NQIs don’t disclose their clients for one or more of three reasons – because there’s no up-side tax benefit, they’re concerned that disclosure might breach local data protection laws, or because they just don’t want to give a potential competitor their client list!

There’s also no tax up-side if the client cannot (or does not) claim a treaty benefit. In this case, the tax rate will be 30% whether the NQI discloses or not, and the multiple withholding agent rule doesn’t apply. That means the ND-NQI should report each beneficial owner separately, per income type received and per counterparty involved. Here the counterparty cannot report the same recipient, because the NQI failed to disclose the necessary information to the counterparty for the rule to apply. It’s the reason why 1042-S reporting codes include ‘unknown recipient’ as an option. When this code is used, it’s with a 1042-S from a counterparty to a non-disclosing NQI that shows the ND-NQI as an intermediary, and the recipient as ‘unknown’.

Of course, this causes some confusion. In one case, we heard of an NQI that claimed that its counterparty has reported the same recipient – an unknown recipient – which, according to them, absolved it under the rule. Nice try, but unfortunately not true. Just because the recipients are unknown, doesn’t make it the same recipient.

It’s a Thin Line

Treading that tightrope is tricky, especially if you’re not all that familiar with the rules. Many NQIs consider disclosing to be a positive thing for a number of reasons. Including the fact that, because the multiple withholding agent rule can be used, the NQI doesn’t have to file any 1042-S forms. And provided that ALL US-Sourced FDAP income has been disclosed, reported and the correct tax has been withheld, the NQI won’t have any US Tax Return Form 1042 obligation either.

But (and there’s always a but), you have to tread carefully. If even one beneficial owner isn’t disclosed, the rule doesn’t apply for the undisclosed beneficial owner. That means the NQI has both a 1042-S reporting obligation and a recipient copy obligation for the undisclosed portion of income, and a 1042 tax return to file.

It’s not unheard of that a receiving counterparty (e.g. A QI) doesn’t necessarily withhold at the correct rate. If any documentation or withholding statements indicate a treaty rate, then this is the rate that must be applied. If the QI tried to avoid the workload and complexity of reviewing all of the documentation and applying the treaty rate by taxing it all at 30%, then it’s over-withholding, and again the multiple withholding agent rule doesn’t apply for the NQI. Unsurprisingly, these situations are just complicated enough to cause problems, with people making incorrect interpretations of the regulations (as the NQI did earlier). NQIs are typically the least knowledgeable about US withholding tax, and so most likely to fall into this trap. And yet despite all of this, many NQIs don’t disclose their clients. For all of these ND-NQIs the multiple withholding agent rule can’t be applied, leaving the NQI with both a US tax return obligation on Form 1042 and an information return obligation on Forms 1042-S, along with a recipient copy obligation to top it all off.

Confused, and don’t know where you stand? We can help. Our expert team at TConsult have decades of experience in US withholding tax, unpicking all of the complicated webs inside it to provide the best advice possible to financial institutions the world over. If you’d like to find out more, you can get in touch with the team today, or buy the book on US withholding tax by our chairman Ross McGill.