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June 24, 2024
2024-1246

IRS clarifies changes to 2023 QI agreement in new FAQs

  • The new FAQs address when a Qualified Intermediary (QI) must assume primary withholding responsibility for payments of substitute dividends.
  • The new FAQs also give information about the IRS's new QAAMS portal that QIs will be required to use for applying, renewing or terminating their status as QIs.
 

The IRS has added several questions and answers to its Frequently Asked Questions (FAQS) for QIs on substitute dividends and periodic-review certifications. The new FAQs clarify changes made to the QI Agreement in Revenue Procedure 2022-43 (see Tax Alert 2023-0011). The new QI Agreement applies for QI agreements effective on or after January 1, 2023. The QI agreement established under Revenue Procedure 2017-15 expired on December 31, 2022.

Substitute dividends

New FAQ #3 under Provisions for 2023 QI agreement, added June 5, 2024, addresses whether QIs must assume primary withholding responsibility for substitute dividends, or whether they can rely on other withholding agents who pay them to do the withholding. The revised QI Agreement added language to section 3.03(A) that states, "A QI … acting as an intermediary under this Agreement for a US source substitute dividend payment must also assume primary withholding responsibility for all US source substitute dividends received and paid by QI as an intermediary." Many QIs objected to this language, noting that US withholding agents (and larger QIs that are clearing organizations) generally did the withholding, so requiring QIs to always assume the withholding responsibility would be a significant change in practice without apparent benefit to the US Treasury.

The new language applies when the QI is not acting as a qualified securities lender (QSL). Under Notice 2010-46, withholding does not apply to substitute dividends that QSLs receive, but QSLs must withhold when paying substitute dividends. The IRS has stated that it wants to end the QSL program, but Notice 2024-44 extended the sunset date to December 31, 2026 (see Tax Alert 2024-1100).

In FAQ #3, the IRS clarifies that, despite the new QI Agreement language, a QI must only assume primary withholding responsibility under certain circumstances. FAQ #3 explains that the language added to Section 3.03(A) was intended to apply after the QSL sunset and "does not apply before such time." Even after that time, the QI will not be required to assume primary withholding responsibility unless it cannot establish that it is receiving the substitute dividend from a US withholding agent, another QI or a withholding foreign partnership (WP) that is withholding on the payment.

EY observes: Representatives of the IRS made informal comments (at the Executive Enterprise Institute (EEi) on June 7, 2024) that the main concern they intended to address in Section 3.03(A) of the QI Agreement is US-source substitute dividends paid by foreign borrowers of stock. Unless such borrowers are QIs or WPs, the IRS believes they are unlikely to comply with the obligation under US law to act as a withholding agent. FAQ #3 allows QIs to continue the current practice of allowing upstream withholding agents to do the withholding on substitute dividends, even after the QSL sunset, so long as those withholding agents are in a category that the IRS can review for compliance.

Periodic review certifications

New FAQs #24 and 25 under Certifications and periodic reviews, added June 7, 2024, provide general guidance for QIs required to submit certifications for a periodic review period covering 2021, 2022 and 2023.

The prior QI Agreement established under Revenue Procedure 2017-15 expired on December 31, 2022. The new QI Agreement in Revenue Procedure 2022-43 was effective on January 1, 2023. Therefore, it is possible for a QI to currently have a periodic review period falling under both the prior QI Agreement (i.e., 2021 and 2022) and the new QI Agreement (i.e., 2023). The QI portal on the IRS website (QAAMS) has been updated to incorporate the changes in Revenue Procedure 2022-43, including:

  • Updates to the Periodic Review report in Appendix I (which includes certain information, based on the testing of accounts and transactions for one calendar year in the three-year period)
  • New Appendix III, which requires certain information and reconciliations about Form 1042 and 1042-S filings for years that are not in the periodic review

FAQ #24 outlines how to complete the periodic review report (i.e., Appendix I) in the QAAMS portal for QIs that select either 2021 or 2022 as their periodic review year. The following is a general overview of the instructions in the FAQ:

Revenue Procedure 2022-43

FAQ #24, Instructions for QIs selecting 2021 or 2022

Appendix I Part

General Requirements

Part I

General QI information

QIs should complete Parts I and II for all three years (2021, 2022, 2023)

Part II

Certification of internal controls

Part III

Waiver

Not addressed in the FAQs

Part IV

A

General information

QIs should include any payments applicable to income code 27 (i.e., publicly traded partnership (PTP) distributions of effectively connected income)

B

Information on accounts and review of accounts

QIs should complete Stratum A, B and C in the table provided in FAQ 24 if they used the safe harbor sampling method in Appendix II of the 2017 QI Agreement

EY observes: The stratums appear in the 2023 QI Agreement as follows:

  • Stratum A: Top dollars related to PTP
  • Stratum B: Direct foreign & US exempt
  • Stratum C: Direct US non-exempt
  • Stratum D: Indirect

The instruction in the FAQ is confusing because it references new Stratum A, which is for PTPs. The FAQ likely should refer to Stratums B-D rather than A-C.

C

Documentation

QIs must provide both pre-cure totals and post-cure totals in each place requested. Post-cure means any curing that happened after the selection of the sample.

The periodic review report should include the dates on (or time during) which curative documentation was received for accounts.

EY observes: Per the QI Agreement, a QI can continue to cure until 60 days after receiving a deficiency assessment from the IRS. It is likely that the IRS will reopen a submitted submission to allow the QI to adjust its post-cure number. When applying for a waiver, a QI must submit the results reported without regard to any curing or remediation.

D

Withholding

Not addressed in the FAQs

E

Reconciliation of reporting on payments of reportable amounts

F

Reconciliation of withholding on reportable amounts

QIs must complete new questions 3, 4 and 9, which were added to the 2023 QI Agreement:

"(3) The total withholding reported by QI on Forms 1042-S"

"(4) Amount of variance (if question 1 plus question 2 does not equal question 3) and attach an explanation for any variance"

"(9) Amount of credit or refund claimed by QI for account holders not supported by appropriate documentation for reduced withholding"

G

Other information (including reporting of US account holders).

QIs should enter 0 for questions 1-3 in a section 10.05(C)(11) and (D)(4) of the 2023 QI Agreement:

  • "The aggregate number of Forms 1099 QI failed to file (when required) with respect to account holders receiving reportable payments"
  • "The aggregate number of Forms 8966 (or analogous forms under an applicable IGA) that QI failed to file under its applicable requirements as an FFI (for accounts receiving reportable payments)"
  • "The number of Forms 1099 and Forms 8966 (or analogous forms under an applicable IGA) that QI filed but that failed to include accurate information on the income and other information required"

QIs should select N/A for question 4:

  • "If QI acted as a QSL or otherwise assumed primary withholding responsibility for a payment of U.S. source substitute dividends as an intermediary, indicate whether QI has a policy in effect to assume primary withholding responsibility for all such payments, to the extent required for any year governed by the certification"

EY observes: The QI should follow these instructions and essentially skip these questions. In other words, the prescribed responses are workarounds to allow QAAMS to consider the submission complete.

Part V

QDD (reserved)

Not addressed in the FAQs

Part VI

Substitute interest (when QI has assumed primary withholding responsibility)

Not addressed in the FAQs

Part VII

IRC Section 1446 — PTP related payments

A QI should select "Yes" to this question — "Did you select a periodic review year prior to 2023?"

QIs should then proceed to Appendix III of 2023 QI Agreement. No further entries are required for Part VII.

EY observes: Based on the current functionality observed in the QAAMS portal, it appears that the Appendix III submission will be made by completing a table in the portal, not by attaching a QI-created Excel table.

IRS representatives provided informal comments (at the EEi on June 7, 2024) on Appendix III, including the following. If a waiver is requested, Appendix III will be required for all three years. If the QI is completing a periodic review (i.e., is not requesting a waiver), Appendix III must be completed for the other two years that are not part of a periodic review. The QAAMS portal should have functionality to carry over the information entered for the periodic review year into Appendix III based on the periodic review year selected. For the last year of the certification period (Year 3), the IRS is looking at what is practical; as of right now, the IRS is "expecting" the submission of the reconciliation for all three years.

The QAAMS portal appears to have the functionality to enter "Zeros" in Appendix III to proceed with the QI periodic review submission. Based on the informal IRS comments, however, it is likely that the IRS will request Appendix III to be completed (post submission) and provide a timeline for delivering. It also appears that the IRS is planning to publish a series of FAQs (like the one above) to address what to input based on the review year selected and how to navigate the new system.

EY observes: It is unclear whether the QAAMS functionality will permit a QI to modify the Appendix III information for the periodic review year that was carried over from the other portion of the certification. Further, it is unclear how Appendix III can be completed for the third year of the certification period when the certification is due before the filing of the Form 1042.

FAQ #25 lists items that QIs should consider when completing a periodic-review submission in QAAMS. The FAQ also outlines six scenarios that may be encountered (which appear to relate to QAAMS system functionality):

  • QIs that have not created a consolidated compliance group (CCG) may see questions in Part I on a CCG
  • When reviewing its responses, a QI may not see certain questions and responses in QAAMS when a qualified certification is being completed in Part II
  • QIs requesting a periodic review waiver in Part III may encounter pages in the QAAMS portal skipping, thereby requiring the use of the "back button" to navigate
  • QIs requesting a periodic review waiver in Part III may see the option to select Part VII in the QAAMS progress bar, which is not relevant to the waiver request (and is not required to be completed)
  • QIs may not see certain responses in Part VII when reviewing their responses before submission
  • QIs may encounter a replacement character (?) when a section symbol (§) is used to reference a regulation (or other) citation

EY observes: QIs should familiarize themselves with the new QAAMS portal well in advance of the submission deadline for their applicable periodic review and confirm their ability to access and navigate through the portal. This will be the first time that QAAMS will be used for submissions and the FAQs note that several system-related issues may be encountered.

The system typically provides an opportunity to review all responses provided before making the submission. However, two of the items in the FAQ describe situations where the QI can input a response but cannot review that response before submitting the certification. The FAQ notes that "answers to these questions are captured by the system and will be viewable to the QI Team." For scenario 2 and 5 above, a QI should consider enhanced review and confirm they have inputted their responses for those situations.

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Contact Information

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Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor
 

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