The US tax system is one of the biggest in the world, which of course means that changes will have a ripple effect on the wider market. FATCA has been one of the biggest in recent history, and it caused a lot of fundamental changes in the way other tax markets operate. In particular, ensuring financial institutions need to use some form of the US W-8 series form to gather information about their customers’ FATCA (US tax) status.

The W-8 series of forms are paper forms updated from time to time by the US Internal Revenue Service (IRS), and there are several types:

• W-8BEN for individuals
• W-8BENE for entities and certain types of trust
• W-8ECI for customers with income effectively connected with a US trade of business
• W-8EXP for customers that are governments or international bodies
• W-8IMY for intermediaries and certain types of tax-transparent trust

The W-8 forms do several things for the IRS, and there are around 900 million W-8s in circulation at any one time. And there is one thing they all have in common – they need to be validated.

What The W-8 Does

The W-8 form addresses two chapters of the US Internal Revenue Code (or IRC)  – Chapter 4 (FATCA) and Chapter 3 (QI/NQI).

I’ve mentioned them specifically in that order because that’s the way the IRS rules require the due diligence and validation rules to be followed. Both chapters have the possibility that US-sourced FDAP income paid to a client may need to be taxed. That would be 30% in the case of Chapter 4, and either 30% or a lower tax treaty rate under Chapter 3. These rules are based on the principle of non-duplicative taxation (i.e., if there’s a tax to withhold in Chapter 4, then there isn’t any tax to withhold in Chapter 3). If there’s no tax to withhold in Chapter 4, then withholding in Chapter 3 is at the correct rate based on the statements made on the W-8 – provided it was properly validated.

The Need for Validation

To add an extra layer of complication, the latest versions of the W-8 also include the provision for taxation of gains from the sale of interest in publicly traded partnerships (PTPs). This adds more complexity, as well as changes the process once the form is validated.

All of these intricate withholding rules come from the existence of a W-8, and the way in which the requesting financial institution validated the form. As you can already see, it’s not as simple as it seems on the surface, and certainly not as simple as some IT folks seem to think! So let’s take a closer look at the validation of W-8 forms and the process they have to go through. If you’re following the modern digitisation trends, you’ll need to build an entire tax logic environment to make sure you don’t end up on the end of a serious IRS penalty, or worse.

The latest versions of the W-8 also include the provision for taxation of gains from the sale of interest in publicly traded partnerships (PTPs). This adds more complexity, as well as changes the process once the form is validated.

Genuine vs Substitute Forms

Anything that’s not an IRS-issued paper form is called a substitute form. Substitute forms are allowed and even encouraged, as long as additional measures are taken and the correct rules are followed for substitute forms. For example:

Some firms have decided to recreate the W-8 forms in their own internal IT system as a way to get their clients to electronically sign the forms. That’s fine, as long as the rules around electronic signatures are met.

Other firms have tried to digitise the W-8s themselves so that the paper form (or facsimile) never exists. That’s not fine, because the IRS rules require a hard copy of the form to be available on request. So while a digital signature is fine, there needs to be a physical copy in existence.

In all of these cases, there are specific additional rules to follow so that you can use a substitute form instead of the IRS original. Of course, that doesn’t mean people haven’t tried to get around it. Several firms have tried to shortcut the regulations by just adding a tick box to their KYC and AML onboarding systems where the customer is asked to confirm whether or not they’re American. Very smart, but also very much not allowed. That’s because there are several tasks associated with the use of a W-8 that can’t be done using this tick-box approach.

Validation Tests

The US rules on W-8s can be complicated at the best of times. Whether you’re using a substitute form or the real thing, you still need to put it through 3 three tests to make sure you meet the rules. If you’re a financial institution, then you will be the ‘requestor’ of the form, and there are rules for how and when you have to request W-8 forms from your customers. The tests are as follows:

Test 1: The ‘validity on the face’ test, otherwise known as VOTF. To pass this test the requestor must check to make sure that the form is the correct type of form, the correct version, and that the data on the form is internally consistent. This is more difficult than it sounds, since most requestors don’t want to (or aren’t licensed to) give tax advice – and so they don’t want to tell their customer which form they think they should be completing. When you do receive that form, you have to decide whether it’s the right type of form. The most common error we see is receiving a W-8BENE from a client, only to find that they’re actually a financial institution. Since the only way a W-8BENE is the right form is if the account they’re opening is for their proprietary assets, and not those of their own clients.

We’re in test 1 and it’s already starting to get complicated!

Once you’ve got the right type of form, you then need to check that it’s the most current version. Again, this isn’t as simple as it sounds. For example, if you’re collecting the form just for Chapter 4 (FATCA status), then the forms are ‘evergreen’, which means they only become invalid if there’s a change in circumstance. But if you’re collecting them for Chapter 3 and Chapter 4, then the form will be valid for three years from the end of the year it was signed. The most current version of these forms (at time of writing) is October 2021. You’ll need to keep track of this when we come to talk about renewals.

Finally, you need to make sure that all of the data on the form is correct and consistent. That means that there are no parts of the form that are impossible based on what the applicant is saying, and you need to be explicitly sure of this. We see a lot of people trip up on this when it comes to W-8BEN and W-8IMY, because those forms are much more complex. In fact, most financial firms still use the original paper forms and manual validation procedures for these types of customers, even if they have a digital version for individuals, just because it’s simpler to validate them.

All of that is just test 1! Ready for test 2?

Test 2: If the form passes the first test, you then need to check it against other data obtained by the requestor. This is a lot easier nowadays, since most KYC and AML information is collected and stored digitally. That said, you still need to be able to prove that you’ve completed the tests. That means asking – does the data on the W-8 form match the data in your KYC and AML database? If it doesn’t, then you’ll need to reject the W-8 form and get another from the client. If it does all match, you’ll need to make sure you have an audit trail to show that this test was performed, and the form passed.

Test 3: Now for the third and final test. At this stage, the requestor needs to check for two things –  ‘reason to know’ or ‘actual knowledge’. And since the IRS likes to save the best for last, this one is the most complicated and risky test to perform, because it isn’t a data-based test. But the results need to be recorded so that a requestor can prove that they properly validated the form to a Reviewer.

The question is – is there anything else that gives the requestor actual knowledge, or reason to know that the statements made on the form are untrue or misleading? This is especially important if the person is making a claim of exemption or a tax treaty rate claim. The answer might not be present in your data or documentation, so this is relying heavily on your knowledge and judgement. You cross the ‘reason to know’ line if a reasonable, independent, prudent person with the same facts would come to the same conclusion. If you have reason to know or actual knowledge, then you’ll need to apply the presumption rules for the appropriate chapter.

Validation Don’ts

Whew! That’s a lot to get through. And the key takeaway is this. If you collect W-8 forms, DON’T:

• just put them in a filing cabinet and never think about them again.
• just check that the name on the form is correct
• just check if the form is signed and dated.

These are NOT enough. Instead, you might want to use a digital, electronically signed substitute form. Within three years you could have all clients brought into a digital landscape by just replacing paper forms with digital ones as the old forms naturally expire.

Don’t forget, if you’re a QI this will be the first set of tests that your independent reviewer will be looking at during your Periodic Review. It’s the first hurdle, and if you can’t prove that you’ve done the tests on every single client account, then it may count as a material failure or an event of default, both of which can put your QI and FATCA status at risk.

At TConsult we see these issues crop up all too often. That’s why we designed, built and launched a single digital, electronically signed version of all the W-8 series forms (and W-9) in one investor self-declaration (The ISD platform). In this system, we perform over 200 tests in order to validate these substitute forms so that the financial institution, whether they are a QI or NQI, can have confidence in their onboarding. We’ve also partnered with Muinmos’ KYC/AML platform, which means we can provide a fully digital experience to a much wider market. With our system and support, financial institutions have the assurance they need to meet their validation requirements every time. If you’d like to find out more, just get in touch with the team today.