The IRS on December 13 issued Rev. Proc. 2022-43 setting forth the final qualified intermediary (QI) agreement (QI agreement) that applies beginning January 1, 2023 (the 2023 QI agreement) when the final Section 1446(f) regulations issued in 2020 became effective and the current version of the QI agreement (2017 QI agreement) expired. The 2023 QI agreement generally adopts changes proposed by the IRS in Notice 2022-23, which expanded the scope of the QI agreement to apply to QIs (1) effecting transfers of interests in publicly traded partnerships (PTPs) or (2) receiving distributions made by PTPs on behalf of QI account holders. QIs are permitted to assume withholding and reporting responsibilities for purposes of Sections 1446(a) and (f).
Action item: Taxpayers who utilize QIs to invest in PTPs on behalf of their customers or account holders should be aware of and review the changes to the QI agreement. These changes broaden the way QIs may be used and require modifications to existing controls, procedures, and operations. Some provisions are elective; other provisions are mandatory.
The IRS on October 7, 2020 released final Section 1446(f) regulations requiring brokers to withhold 10% on the “amount realized” on transfers made by foreign partners of interests in PTPs that are effected by the broker, unless an exception from withholding applies.
The provisions of the final regulations related to withholding on transfers of PTP interests and PTP distributions apply to transfers and distributions that occur on or after January 1, 2023. See our Insight Withholding and information reporting on the transfer of publicly traded partnership interests for more information. The final Section 1446(f) regulations permit QIs to act as nominees for purposes of assuming primary withholding responsibilities on distributions from PTPs by assuming primary withholding responsibility for the entire distribution. The 2017 QI agreement did not permit QIs to act as QIs with respect to amounts subject to Section 1446(a) withholding on PTP distributions received on behalf of account holders, but the 2023 QI agreement has been modified to incorporate QI requirements with respect to Sections 1446(a) and (f).
A QI is permitted to document the status of an account holder that is a partner in a PTP as either a foreign or US person for purposes of Sections 1446(a) and (f) under requirements generally similar to those for payments subject to Chapter 3 or 4 withholding. However, a QI that acts as a disclosing QI by providing specific partner documentation to a withholding agent for withholding under the final regulations is permitted to document the status of an account holder based only on a withholding certificate. A QI also must document an account holder using only a withholding certificate for purposes of applying an exception to withholding that is based on an account holder’s claim under an income tax treaty or for applying an exception to withholding for an entity described in Section 501(c). A QI may not reliably associate a payment of an amount realized with the account holders of a nonqualified intermediary regardless of whether specific information about the account holders of the nonqualified intermediary is provided to the QI. A QI that is unable to reliably associate a payment of an amount realized or an amount subject to withholding on a PTP distribution with valid documentation must treat the account holder as a foreign person under the presumption rule added to the QI agreement and withhold at the applicable rate, except when backup withholding would apply to an amount realized. Observation: While QIs generally may rely on “know your customer” (KYC) documentation for purposes of Sections 1446(a) and 1446(f), a disclosing QI must provide the PTP or broker with a US reliable withholding certificate rather than KYC documentation. Thus, QIs that currently rely on KYC documentation in lieu of withholding certificates must create internal processes or find outside providers to solicit, validate, store, and refresh withholding certificates if they wish to function as a disclosing QI for Sections 1446(a) and 1446(f) purposes. Failure to properly comply with these documentation requirements could result in withholding on payments to the QI or create tax and penalty exposure for the QI.
Notice 2022-23 proposed that a withholding certificate is not considered valid without a US TIN for the account holder on the withholding certificate. In response to comments and difficulties QIs may encounter in obtaining US TINs from all their account holders holding PTP interests, the 2023 QI agreement provides that beginning January 1, 2023 QIs must follow certain written solicitation requirements in collecting US TINs from their account holders receiving PTP distributions or amounts realized. A QI satisfying these requirements will be considered to have made its “best efforts” to obtain the US TINs. Observation: This provision is intended to address concerns that a QI would not be able to act as a disclosing QI for the entire amount of a payment made to multiple account holders if any account holder fails to provide its US TIN despite the QI’s efforts to obtain the TIN. The 2023 QI agreement makes clear, however, that this does not affect a QI’s requirement to collect valid documentation (whether a US withholding certification or KYC documentation) with a US TIN to apply reduced withholding under Section 1446(a) or Section 1446(f).
For a QI not acting as a disclosing QI for a PTP distribution or amount realized to an account holder, Notice 2022-23 proposed requiring the QI to issue to the account holder a statement under Reg. sec. 1.6031(c)-1T covering the person’s distributive share of partnership income, gain, loss, deduction, or credit required to be shown on the partnership return with respect to an account holder holding a PTP interest. In response to a comment requesting the allowance of a simplified or modified Schedule K-1 that a QI would be permitted to issue to an account holder in lieu of a separate statement, the 2023 QI agreement permits a QI to provide to the account holder the Schedule K-1 issued by the PTP to the QI if the QI includes with the Schedule K-1 supplemental information indicating the percentage of each amount on the Schedule K-1 applicable to the account holder. This statement is not required to the extent a nominee (i.e., any entity that holds a PTP interest directly or indirectly for another person) maintains fully segregated and disclosed amounts for the disclosing QI’s account holders that includes the information for the PTP to issue the statement. The statement must provide a US TIN for a foreign account only when provided by the account holder to the QI.
The 2023 QI agreement permits QIs to assume primary withholding responsibility under Sections 1446(a) and (f) on a payment-by-payment basis based on a valid withholding certificate. Consequently, a QI that assumes primary withholding responsibility on any portion of a PTP distribution must assume withholding requirements for both PTP distributions and the amount realized on the sale of a PTP interest. A QI that does not assume primary withholding for payments is permitted to provide its withholding agent with withholding statements and other information and is subject to the same residual withholding requirement that applies when another withholding agent withholds less than the required amount. Observation: Taxpayers have been provided flexibility to choose whether to assume primary withholding responsibility under Sections 1446(a) and 1446(f) separately from their existing position on withholding under Sections 1441 and 1471. However, the same considerations regarding whether to assume primary withholding responsibility (e.g., calculation and remittance of tax, control of account holder information, and customer demand) will remain.
The 2023 QI agreement generally retains the provisions of the 2017 QI agreement with certain clarifications, including some guidance for QDDs that are a partnership or a branch of a partnership (QDD partnership). Consistent with the 2017 QI agreement, if a QI acts as a QDD with respect to the home office or branch, the home office or branch must act as a QDD for all payments made as a principal with respect to potential Section 871(m) transactions and all payments received as a principal with respect to potential Section 871(m) transactions and underlying securities, excluding any payments made or received to the extent treated as effectively connected with the conduct of a trade or business within the United States. The QI may not act as a QDD with respect to any other payments.
Consistent with Notice 2022-37, the 2023 QI Agreement provides that a withholding agent may not act as a QSL for payments made after 2024. Until December 31, 2024, a QI not acting as a QDD, but acting as a QSL, must act as a QSL and assume primary withholding responsibility (including Form 1099 reporting) for all substitute dividends received and paid by the QI when acting as an intermediary or dealer with respect to securities lending and similar transactions. A QI that acts as a QDD may not act as a QSL, except as with respect to payments on securities lending or sale-repurchase transactions for which the QI has determined that it is acting as an intermediary. QIs acting as intermediaries (but not as QSLs) for substitute dividends also must assume primary withholding responsibility with respect to all substitute dividends when acting as intermediaries.
The 2023 QI agreement provides that a QDD must assume primary Chapter 3 and Chapter 4 withholding and reporting responsibility and primary Form 1099 reporting and backup withholding responsibility under Section 3406 for payments made as a QDD with respect to potential Section 871(m) transactions. In addition, a QI acting as a QDD remains liable for its QDD tax liability and must report that liability on the appropriate US tax returns. US financial institutions and US partners of any QDD partnership must pay appropriate US taxes on the relevant QDD’s activities. The 2023 QI agreement clarifies that a QI that is a QDD (or has a branch that is a QDD) should file (1) a Form 1120, U.S. Corporation Income Tax Return, if it is a domestic corporation; (2) a Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, if it is a foreign corporation; or (3) a Form 1065, U.S. Return of Partnership Income, if it is a partnership. In addition, all QDD partnerships must file Forms 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, with respect to any amounts under the 2023 QI Agreement, as modified for a QDD partnership, allocated to each of their foreign partners. The Form 1120-F or Form 1065 must be filed whether or not it would have to be filed if the entity were not a QDD. Although the Form 1065 does not have a Schedule Q, each QDD of a QDD partnership must provide comparable information. Observation: While a QDD is not required to perform a periodic review for calendar years 2023 and 2024 with respect to its QDD activities, the 2023 QI agreement requires a QDD to certify, as part of its periodic certification, that it made a good faith effort to comply with the Section 871(m) regulations and relevant provisions of the 2023 QI Agreement. The 2023 QI agreement adds that a QDD must include information about dividends received in its equity derivatives dealer capacity on its withholding statement for 2023 and 2024.
Notice 2022-23 proposed a modification to the QI agreement for the issuance of a recipient-specific Form 1042-S for a payment subject to withholding on a PTP distribution or under Section 1446(f). This proposed modification would require a QI to provide a recipient-specific Form 1042-S to a foreign partner for a payment only when the partner provides its US TIN (or indicates it has applied for a US TIN) to the QI and requests the form within three calendar years of the year of the payment. Comments on this proposed requirement questioned whether a QI should in all cases defer issuing a Form 1042-S until the account holder provides its US TIN to the QI. In response to concerns and to broaden the proposed modification to cover additional payments subject to withholding, the 2023 QI Agreement generally requires a QI to provide an account holder with a recipient-specific Form 1042-S if the account holder makes a written request for the form within two calendar years following the year of the payment for which the form is requested. If, however, a QI files a Form 1042-S to report a payment subject to Section 1446(a) or Section 1446(f) withholding with respect to an account holder that requests a Form 1042- S for the same calendar year, the request must be made in writing within three calendar years of the year of the payment, and the QI must provide the account holder with a separate Form 1042-S for each amount reportable on Form 1042-S that was paid to the account holder for the calendar year. The three-year period is intended to provide a foreign account holder additional time to request a Form 1042-S due to its own requirement to file a US income tax return to report an amount subject to Section 1446(a) or Section 1446(f) withholding. Also, because an account holder may be required to file a US income tax return in those and certain other cases, even when not requesting a refund of overwithholding, the 2023 QI Agreement does not limit a QI’s requirement to issue a recipient-specific Form 1042-S in cases of overwithholding.
The 2017 QI agreement generally requires the responsible officer of a QI to arrange for the performance of a periodic review, the results of which must be documented in a written report addressed to the responsible officer. The 2107 QI agreement did not require a QI to submit the periodic review report with its periodic certification absent an IRS request for the report. However, the 2023 QI agreement requires QIs to submit a copy of their periodic report with their periodic certification. A QI also must submit a reconciliation of payments made and the amount withheld. Moreover, if the QI makes a qualified certification, the QI also must include its proposed remediation plan with the qualified certification. The 2023 QI agreement adds the requirement to include in the periodic review a sample of a QI’s accounts receiving payments for which withholding may apply under Sections 1446(a) and (f). The population of accounts to be sampled has been expanded to include all accounts receiving a PTP distribution or an amount realized from the sale of a PTP interest. To sample these accounts, the 2023 QI agreement requires a stratum of the 30 top-dollar value accounts, as determined by the total of PTP distributions and amounts realized from sales of PTP interests paid to an account to be segregated from the population of accounts and reviewed.