If you have just completed your US information reporting program for the 2015 tax year – well done! The last twelve months has seen some interesting changes in the Chapter 3 QI and NQI landscape, some of which has been driven by changes in Chapter 4. One of the most interesting changes was the rise in IRS penalties for failure to file information returns on time (1042-S) and also failure to provide accurate information on those returns.

As with FATCA, this slid into US law in 2015 as part of a completely unrelated Bill. As such, for many this was under the radar, especially as the first actual effect wouldn’t be seen until the filing season in March/April of this year. The net effect is that the risk associated with the activity of information reporting just doubled.

For those interested in such things, the Statute involved is Title VIII of the Trade Preferences Extension Act (2015), which passed in June last year. The purpose of this Act has absolutely nothing to do with information reporting. However, like most US Acts, there is an ‘offset’ provision designed to cover the costs associated with the Act itself. In other words, where is the money coming from in tax revenues to offset the costs of implementing the Act? In this case, the ‘offset’ is an almost doubling of the penalties associated with failure to file information returns and failure to provide accurate information on them.

The base penalty that will apply is now $250 per form, capped at an increased rate of $3m. The same penalty applies to meet the obligation to present recipients with their copies of these forms. As some have observed, if you fail to file on time to the IRS, it is likely that you’ll also have failed to present recipients with their copies. So, the potential effect is a penalty of $500 per form and a maximum risk of $6m.

For QIs, this presents a very small risk, as QIs have a much higher awareness of their obligations and are more committed to compliance. They also have fewer forms to submit, so even at $500 a form, the actual financial risk may be only a few thousand dollars. The reputational risk is, of course, much higher for a QI.

The largest impact will theoretically be on non-qualified intermediaries (NQIs) and QIs that have NQIs as customers. That’s because NQI reporting is at beneficial owner level, not pooled as for QIs. So, an NQI who does not disclose their clients to an upstream QI or US Withholding Agent (USWA) bears 100% of the risk if they fail to file. From what I’ve seen in the industry, it is also a truism that if you failed to file on time, it’s a sign that you have insufficient resource, which would also imply that there’s a higher likelihood that when you do file, you’ll make mistakes in the information.

I say ‘theoretically’ because of course the difficulty is that most NQIs have never filed a report in the 16 years of these regulations and the IRS has never publicly penalised any of them to any significant extent. So, while the regulations have teeth, until someone gets bitten with them, NQIs have little incentive to step up to the plate. The riskiest point for an NQI is the point at which they decide (or are forced) to become a QI. At this point, clearly they perceive the prior failures as a risk to their impending QI status. However, anecdotally, the IRS is much more likely to turn a blind eye to prior years in favour of getting more QIs signed up. Most of the consideration of these risks is based on how each firm views the importance of compliance in its ethical structure. In this respect, Asia lags significantly behind Europe and that’s perhaps a combination of cultural differences, sheer distance and the knowledge that no-one in the region has been penalised.

To be complete, that $250 per form penalty does have some reductions associated with it. If you file within 30 days of your due date, the penalty drops from $250 per form to just $50 a form and the cap drops to $500,000. The cap drops further if your average annual gross receipts (of US sourced FDAP income) in the prior three years were less than $5m. In that case, you’re a ‘small business’ and the cap is only $175,000. However, if you miss that 30 day window and you file between then and August 1st, the penalty and cap go up again to $100 a form, capped at $1.5m ($500,000 for small businesses). Remember that’s a penalty system that applies both to your filing to the IRS and to your obligation to present recipients with copies, if you have one.

For further information about the Trade Preferences Extension Act (2015), you can find the Act in full at the GATCA Resource Library in the US section for Chapter 3.

If you would like to know more about the GATCA Resource Library, please visit gatca.info or contact [email protected].

Image Credit: Tom Paugis