May 12, 2022
US | Changes to QI withholding agreement rules expand QI withholding and reporting responsibilities
The United States (US) Internal Revenue Service (IRS) has published changes (Notice 2022-23) to the qualified intermediary (QI) withholding agreement rules that will allow a QI to assume withholding and reporting responsibilities for purposes of Internal Revenue Code (IRC) Sections 1446(a) and (f). Generally, these changes would apply to a QI that sells an interest in a publicly traded partnership (PTP) or receives a distribution from a PTP on behalf of a QI account holder.
The current QI agreement, established under Revenue Procedure 2017-15 (see EY Global Tax Alert, IRS releases 2017 Qualified Intermediary Agreement and FFI Agreement, dated 18 January 2017), will expire on 31 December 2022. An updated QI agreement, effective as of 1 January 2023, will include the proposed changes made in Notice 2022-23.
Final regulations addressing withholding under IRC Sections 1446(a) and 1446(f) (TD 9926; see EY Global Tax Alert, US: Final regulations under Section 1446(f) set forth rules on withholding on transfers of partnership interests, dated 27 October 2020), will also become effective as of 1 January 2023.
Section 1446 withholding
The Tax Cuts and Jobs Act of 2017 (TCJA) added these new statutory provisions:
IRC Section 1446(f) is essentially a collection mechanism for IRC Section 864(C)(8) and imposes the 10% withholding tax when there is a "sale, exchange, or other disposition" on a partnership interest held by a non-US person, and that partnership is directly or indirectly engaged in a US trade or business.
The final regulations, published in November 2020, implement the IRC Section 1446(f) withholding and reporting requirements for PTPs. Under the final regulations, brokers are required to withhold 10% of the gross proceeds on the sale of PTP interests, and on certain PTP distributions, unless an exception applies. The final regulations also introduced several changes to the existing IRC Section 1446(a) requirements on PTP distributions of effectively connected taxable income (ECTI).
Current QI agreement
The current QI agreement allows a QI to assume primary withholding responsibilities under Chapter 3 (non-US resident withholding) and Chapter 4 (FATCA withholding). Alternatively, a QI is permitted to not assume primary responsibilities and instead have the withholding performed by an upstream withholding agent, for example by providing withholding rate pools.
The scope of the current QI agreement does not include IRC Section 1446; therefore, a QI is not currently allowed to act as a QI with respect to PTP distributions received on another account holder's behalf that are subject to IRC Section 1446(a) withholding.
The final regulations expand the scope of the QI agreement to include withholding and reporting under IRC Section 1446(a) or 1446(f). The preamble to the final regulations, however, also noted that the QI changes will be further addressed in a "rider" to the QI agreement. The proposed changes in Notice 2022-23 are the draft of the rider to the QI agreement.
The following summary outlines several of the noteworthy IRC Section 1446 additions and changes included in Notice 2022-23 affecting QIs.
Proposed changes to QI agreement
Under Notice 2022-23, the QI agreement will be updated to allow QIs to assume primary withholding responsibility for sales of PTP interests under IRC Section 1446(f). In addition, QIs can assume primary withholding responsibility for PTP distributions, which includes distributions of:
In general, QIs may assume primary withholding responsibility under IRC Sections 1446(a) or1446(f) on a payment-by-payment basis, regardless of whether the QI assumes withholding under Chapters 3 and 4 for payments other than PTP distributions.
The Notice reiterates that a QI that assumes primary withholding responsibility for any part of a PTP distribution is required to assume withholding responsibilities for the whole distribution (which includes an amount subject to Chapters 3 or 4 withholding on the distribution).
Implications: The guidance is consistent with the updated Form W-8IMY instructions (Rev. October 2021) issued in November 2021. When a QI assumes primary withholding responsibility on PTP distributions, it includes the portions of the distribution treated as US source FDAP (e.g., interest received by the PTP that is being distributed to the partners, as described in a Qualified Notice). This applies regardless of whether the QI assumes primary Chapter 3 and Chapter 4 withholding responsibilities for other payments, such as dividends paid by corporations.
Changes to QI agreement section 6 address how a QI should be documented (i.e., on Form W-8IMY), and what can be provided to upstream withholding agents. A QI will designate whether it assumes primary IRC Section 1446 withholding responsibility on PTP sales and PTP distributions on the updated Form W-8IMY (Rev. October 2021), and accompanying documentation (e.g., withholding statements or payee-specific documentation).
If a QI does not assume primary withholding for PTP sales or PTP distributions, the QI may provide upstream withholding agents with either a withholding statement that includes the applicable withholding rate pools for PTP sales and PTP distributions, or specific payee information and documentation (i.e., acts as a "disclosing QI"). Non-US resident account holders could be included in IRC Section 1446(a) withholding rate pools (i.e., 37%, 21% or 0%) or IRC Section 1446(f) withholding rate pools (i.e., 10% or 0%). For Section 1446(f) withholding on PTP sales, US resident account holders could be included in a US payees pool (if all applicable requirements are satisfied). Otherwise, the US resident account holders' Forms W-9 must be provided by the QI.
Implications: Notice 2022-23 does not explicitly address what additional information must be provided by the QI that is providing payee-specific documentation (e.g., whether a withholding statement that includes allocations (totaling 100%), or referencing gains, must be provided). This may be addressed in the final version of the QI agreement.
A QI that provides withholding rate pool information with respect to an amount realized may combine the withholding rate pool information for its account holders with information on account holders of another QI that is an account holder of the first QI. For a PTP distribution, the QI must determine its withholding rate pools based on each amount subject to withholding on the distribution, as determined by the QI's withholding agent.
The QI can have a "residual withholding responsibility" (for what should have been withheld under IRC Section 1446), even when it does not assume primary IRC Section 1446 withholding responsibilities. This responsibility can arise when the QI knows an upstream withholding agent did not perform the correct withholding, or the QI made an error that resulted in incorrect upstream withholding (e.g., the QI did not provide an accurate IRC Section 1446 withholding statement).
Documenting account holders
Proposed changes to section 5 of the QI agreement will allow a QI to document the non-US resident status of an account holder who is a partner in a PTP using either documentary evidence or Forms W-8. However, there are restrictions to using documentary evidence, including:
Implications: The term "disclosing QI" was first introduced in the updated Form W-8IMY instructions (Rev. October 2021). The "disclosing QI" identifies itself as such by providing payee-specific documentation (e.g., the Forms W-8 of its non-US resident account holders) to an upstream withholding agent. The restriction may be a burden on QIs that only collect documentary evidence.
For purposes of IRC Sections 1446(a) or 1446(f), the proposed changes also indicate that a non-US account holder must provide its US taxpayer identification number (TIN) on its Form W-8, or the QI must obtain the TIN in addition to the documentary evidence.
Implications: The proposed changes do not reference the implications if a US TIN is not provided by a non-US account holder. Additional guidance is needed; however, it appears that a potential consequence of a missing US TIN is that treaty benefits cannot be applied to PTP sales (when applicable). The non-US account holder would also be required to later provide a US TIN to the QI when requesting recipient specific Forms 1042-S (discussed below). Additionally, if the non-US account holder files a US return, it may not be able to get credit for IRC Section 1446 withholding unless it attaches a Form 1042-S that includes the TIN.
In addition, for non-US resident Chapter 3 statuses, the proposed changes to section 5 indicate that reduced IRC Section 1446 withholding rates are not available for international organizations and foreign governments. Tax-exempt organizations, however, may be able to qualify for reduced IRC Section 1446(a) withholding rates.
Implications: The proposed changes appear to indicate a view by the IRS that neither the IRC Section 1446(a) or 1446(f) regulations provide a withholding exemption for international organizations and foreign governments (notwithstanding exemptions under different IRC sections). Tax-exempt organizations may benefit from a reduced IRC Section 1446(a) withholding rate; however, this would only apply if the payment was not unrelated business taxable income (UBTI), which would likely be a very unusual fact pattern for a tax-exempt organization.
Further, a QI will be required to (1) document nonqualified intermediaries, flow-through entities and other QIs to which it pays amounts realized or PTP distributions and (2) describe how the documentation reliably associates with payments made to account holders or interest holders. Under a new "limitation rule," a QI may not reliably associate a payment of an amount realized under IRC Section 1446(f) with a nonqualified intermediary's account holders. As a result, generally, the QI must treat those account holders as foreign persons under the "presumption rule" (added to QI agreement section 5.13(C)(5)) and withhold at the applicable rate under IRC Section 1446(f).
Reporting on Form 1042-S
Changes to QI agreement section 8 will allow a QI to file Form 1042-S on a pooled basis to report amounts realized and amounts subject to withholding on PTP distributions, as is generally permitted for other payments governed by the QI agreement. A QI acting as a disclosing QI is not required to file Form 1042-S (unless it knows or has reason to know that a correct Form 1042-S was not issued to a partner); instead, the QI's withholding agent or broker must file the form. A QI that assumes primary withholding responsibility and receives account holder documentation from a disclosing QI must report on Form 1042-S with respect to the other QI's account holder.
A QI must provide recipient-specific Forms 1042-S (e.g., "pull out" of QI pooled reporting) for payments subject to IRC Section 1446(a) or (f) withholding to non-US resident account holders upon request, but only if the account holder has provided its US TIN, or has indicated in writing that it has applied for a TIN. Such requests can be made to the QI for three full calendar years following the year of the payment.
Implications: The QI agreement allows a QI to pool report its account holders on reportable payments subject to reporting under IRC Sections 1446(a) and 1446(f). However, the instructions to the Form 1042-S require that the PTP be identified on the Form 1042-S as the payor, which may limit the QI's ability to aggregate reportable payments even though the notice permits aggregation of account holders.
Section 8 further incorporates several reporting considerations for QI account holders that are partnerships and trusts:
Nonqualified intermediary (NQI) reporting
Notice 2022-23 lists conditions under which a QI must issue a separate Form 1042-S to report an amount realized under IRC Section 1446(f) paid to an account holder of an NQI. NQIs are subject to 10% IRC Section 1446(f) withholding, unless a Qualified Notice exception applies. The 10% withholding rate applies regardless of whether the NQI's underlying account holders are entitled to a 0% rate (e.g., when documented with a Form W-9). The proposed changes outline two potential reporting treatments for an NQI:
Implications: The same alternative NQI reporting framework was first introduced in the updated Form W-8IMY instructions (Rev. October 2021). The proposed changes to the QI agreement retained the reference to "IRC Section 6045," which governs reporting of securities sales on Forms 1099-B to US non-exempt recipients. If this reference is ultimately included in the updated QI agreement, guidance from the IRS will be needed on how to reflect IRC Section 1446(f) withholding on a Form 1099-B. In addition, reporting IRC Section 1446(f) withholding on a Form 1099-B will create a variance in deposits and on year-end returns (i.e., Forms 1042 and 945).
Reporting on Forms 1099
For payments of broker proceeds that are amounts realized from sales of PTP interests, Section 3 of Notice 2022-23 will not exempt QIs from the responsibility of primary Form 1099 reporting and backup withholding (as otherwise permitted in Section 3.05(C)), if the QI provides the broker with a valid withholding certificate indicating that the QI assumes primary withholding responsibility for the amount realized.
Implications: This provision appears to indicate that a QI that assumes primary IRC Section 1446(f) withholding responsibility on PTP sales, must also assume Form 1099-B (and backup withholding) responsibilities. This Form 1099-B responsibility cannot be shifted to an upstream withholding agent, as is permitted under Section 3.05(C) of the current QI agreement when specific requirements are met (including an agreement between both parties). The Notice, however, does not update Section 8.06 of the QI agreement, which addresses Form 1099 reporting requirements of the QI.
PTP nominee reporting
Generally, Treas. Reg. Section 1.6031(c)-1T(a) provides that a nominee holding a partnership interest on behalf of another person must provide the partnership with certain information (e.g., name, address, taxpayer identification number, and description of the interest) about the nominee or the person on whose behalf the nominee holds the interest. If unable to provide this information, the nominee must provide the partnership with a statement explaining the person's distributive share of income, gain, loss or credit that must be shown on the partnership return.
The new QI agreement will incorporate the provisions of Treas. Reg. Section 1.603(c)-1T "to facilitate the U.S. tax filing of foreign partners required to report effectively connected income from their holdings and sales of PTP interests." Changes in Notice 2022-23 require a QI acting as a disclosing QI to provide the PTP or QI's nominee with the statement described in Treas. Reg. Section 1.603(c)-1T(a) for any account holder holding a PTP interest.
The proposed requirements make a distinction between whether or not the QI is acting as a "disclosing QI":
Private arrangement intermediaries and options for partnerships and trusts
New procedures will be added to section 4 of the QI agreement for QIs that have arrangements with private arrangement intermediaries (PAIs) that hold PTP interests for account holders. The new procedures also will create situations in which a QI may use the agency or joint options in remitting a PTP distribution or amount realized to a partnership or trust. Specifically, a QI may determine its withholding on an amount realized that is paid to a PAI by referring to the status of each of the PAI's account holders and must provide the PAI with a statement described in Treas. Reg. Section 1.6031(c)-1T(a) for each PAI account holder that receives an amount realized or PTP distribution during the year.
Implications: Based on the proposed changes, it appears that a PAI will be treated similarly to a QI for purposes of withholding relief, and not like an NQI. PAIs are currently uncommon, but there is increased interest in PAIs due to the IRC Section 1446 implications.
A QI may use the agency option for a foreign partnership by providing a certification for a modified amount realized or an amount subject to IRC Section 1446(a) withholding on a PTP distribution, unless the partnership is a PTP. For trusts, a QI may apply the agency option only for grantor trusts because a simple trust may not provide beneficiary information for withholding under IRC Section 1446(a) or (f).
Notice 2022-23 does not allow a QI to use the joint account option for PTP distributions or amount realized, largely because the joint account option is not permitted when a partnership or trust has a US partner, owner, or beneficiary.
Refunds and underwithholding
A QI may not file a collective refund with respect to withholding under IRC Section 1446(a) or (f). To rectify overwithholding or underwithholding under IRC Section 1446(a) or (f), a QI may apply the procedures found in QI agreement Chapters 3 and 4.
Default and material failures
Notice 2022-23 addresses material failures and default in cases in which a QI has failed to withhold as required under IRC Section 1446(a) or (f) or failed to comply with reporting requirements under new QI agreement section 8.07.
The IRS requests comments on (1) the text of the proposed changes to the QI agreement, and (2) any compliance procedures that should be added to section 10, Appendix I (information to be provided by the QI) and Appendix II (statistical sampling procedure for QI reviewer to use in period review) of the QI agreement. Comments should be submitted by 31 May 2022, refer to Notice 2022-23, and be sent electronically to www.regulations.gov.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (United States), Financial Services Organization