After approximately 18 months of taxpayer anticipation, the US Internal Revenue Service (“IRS”) has released Notice 2022-231 (the “Notice,” which has also been unofficially referred to as the “QI rider”), which proposes changes to the Qualified Intermediary (“QI”) Agreement that will permit a QI to assume withholding and reporting responsibilities for purposes of Sections 1446(a) and (f).
The preamble to the final regulations promulgated under Section 1446(f), which implemented the withholding obligations with respect to dispositions of interests in partnerships engaged in a trade or business within the United States by non-US persons, previewed that the IRS was planning to update the QI Agreement (Rev. Proc. 2017-15) to allow QIs to assume primary withholding responsibilities on amounts realized under Section 1446(f) and on distributions by publicly traded partnerships (“PTPs”)2 under Section 1446(a).
As a general matter, the QI Agreement allows foreign persons to enter into an agreement with the IRS in order to simplify certain of their obligations under chapters 3 (non-US resident withholding and reporting), 4 (FATCA), and 61 (Form 1099 reporting) of the Code3 and for purposes of section 3406 (backup withholding). The Notice sets forth proposed changes to the QI Agreement that apply to a QI effecting a transfer of an interest in a PTP or receiving a distribution made by a PTP on behalf of an account holder of the QI. (The Notice does not address similar rules relating to transfers of interests in a non-PTP, which was addressed in the regulations promulgated under Section 1446(f).)
The Notice provides that the proposed changes, subject to any modifications based on public comments received and accepted, will be incorporated into an upcoming final QI Agreement, that will apply to QI agreements that are in effect on or after January 1, 2023. (The QI Agreement currently in effect4 expires on December 31, 2022.) The forthcoming QI Agreement will incorporate additional requirements for QIs under Sections 1446(a) and (f) that are not addressed in the Notice, such as the relevant periodic review requirements and compliance procedures. The Notice specifically requests comments relating to such requirements. Written comments should be submitted to the IRS by May 31, 2022.
The following sections of this Legal Update highlight some of the updates to the QI Agreement proposed by the Notice.
Withholding under sections 1446(a) and (f)
A QI is permitted to assume primary withholding responsibilities with respect to amounts realized from the sale of PTP interests and on PTP distributions on a payment-by-payment basis, regardless of such QI’s assumption of primary withholding responsibilities with respect to chapters 3 and 4 for payments other than PTP distributions. Note that a QI that assumes primary withholding responsibility on any portion of a PTP distribution will be required to assume withholding responsibilities for the entire distribution, including on amounts subject to withholding pursuant to chapters 3 and 4.
To assume primary withholding responsibilities on amounts realized from the sale of a PTP interest, the QI must provide the broker making such payment with a valid Form W-8IMY certifying that it assumes primary withholding responsibility for the payment. If a QI assumes primary withholding responsibility with respect to amounts realized from the sale of a PTP interest, the QI is generally required to withhold 10 percent of the amount realized paid to a transferor that is (or is presumed to be) a foreign partner, absent an exception to such withholding. Similarly, to assume primary withholding responsibilities on PTP distributions, the QI must provide the PTP or the nominee paying the distributions with a valid Form W-8IMY certifying that the QI assumes primary withholding responsibility by acting as a nominee for the distributions.
Note, however, that a QI is generally not required to assume primary withholding responsibilities with respect to PTP interests. A QI that does not assume primary withholding responsibilities with respect to PTP interests will be required to provide the withholding agent or broker making such payment to the QI with a valid Form W-8IMY stating that the QI does not assume primary withholding responsibility, along with a withholding statement that includes either applicable withholding rate pools with respect to PTP sales and distributions or payee-specific information and associated payee documentation (i.e., a QI that acts as a “disclosing QI” provides payee-specific information). Even where a QI does not assume primary withholding under Section 1446(a) or (f) for a payment, the QI may nevertheless have residual withholding obligations (i.e., to the extent a withholding agent or broker making payment to the QI underwithheld and (i) the QI has actual knowledge there has been underwithholding by another withholding agent or broker, or (ii) the QI made an error that resulted in a payor failing to withhold the correct amount on payment to the QI).
Documentation for purposes of Sections 1446(a) and (f)
Under the current QI documentation requirements5, a QI agrees to use its best efforts to obtain documentation from account holders that receive a reportable payment to determine whether withholding applies or whether a payment is reportable under the QI Agreement. As a general matter, the documentation can be in the form of documentary evidence or a withholding certificate (e.g., a Form W-8). If a QI is unable to obtain valid documentation, it must apply a series of presumption rules to determine whether withholding is required on payments made to the account holder.
The Notice modifies Section 5 of the QI Agreement so that a QI is also permitted to document the status of an account holder that is a partner in a PTP as a foreign person for purposes of Section 1446(a) and (f) under requirements generally similar to the existing documentation rules, i.e., obtaining documentary evidence or IRS Forms. However, when a QI acts as a disclosing QI by providing specific partner documentation to a withholding agent, the QI is permitted to document the status of an account holder based on a withholding certificate only. In other words, a QI that desires to act in a disclosing QI capacity must collect withholding certificates from its applicable account holders in order to provide such documentation to its withholding agent. In addition, a QI must also document an account holder using only a withholding certificate for purposes of applying an exception to withholding under Section 1446(a) or (f) based on an account holder’s claim under an income tax treaty.
In order for documentation provided by an account holder that is a partner receiving a distribution or an amount realized with respect to a PTP to be valid, such account holder’s US taxpayer identification number (“TIN”) must be provided. This requirement may present a practical issue for many non-US account holders who may not have, or be able to timely obtain, a US TIN. The Notice does not provide any transitional relief for current account holders of a QI who have not provided a US TIN.
The modifications also include requirements for QIs to document nonqualified intermediaries, flow-through entities, and other QIs to which a QI pays amounts realized or PTP distributions and describe how a QI reliably associates the documentation with payments made to account holders or interest holders in those entities, including certain limitations on the ability of a QI to rely on documentation provided by a nonqualified intermediary.
QI withholding certificates and withholding statements
The Notice 2022-23 modifies the documentation rules applicable to the QI itself by allowing a QI to provide a valid IRS Form W-8IMY when paid a PTP distribution or amount realized from the sale of a PTP interest. As previously mentioned, to the extent a QI does not assume primary withholding responsibility with respect to PTP interests, the QI must also provide to its withholding agent or broker making payment to the QI a withholding statement that includes applicable withholding rate pools or, to the extent the QI is acting as a disclosing QI, specific payee information, including underlying payee documentation. The concept of a disclosing QI, i.e., a QI that provides specific payee information and underlying payee documentation, is a novel concept with regards to QIs.
Reporting on Form 1042-S
The Notice modifies a QI’s Form 1042-S reporting requirements to generally permit a QI to file Forms 1042-S on a pooled basis to report amounts realized and amounts subject to withholding on PTP distributions to the same extent generally permitted for other payments covered by the QI Agreement. However, if a QI acts as a disclosing QI, the withholding agent or broker for the QI is required to file Forms 1042-S with respect to the account holders of the QI that are partners in a PTP, and the QI is not required to file a Form 1042-S unless it knows or has reason to know that a correct Form 1042-S was not issued to a partner. This Form 1042-S reporting requirement is consistent with a disclosing QI’s obligation to provide payee-specific information and payee documentation to its withholding agent or broker.
In cases in which a QI does not act as a disclosing QI it must also issue a separate Form 1042-S when requested by an account holder under specific conditions.
Requirements under Treasury Regulation Section 1.6031(c)-1T (nominee reporting)
Treasury Regulation Section 1.6031(c)-1T generally provides for the coordination of information between a partnership and a nominee holding an interest directly or indirectly in the partnership on behalf of another person. More specifically, the treasury regulation requires the nominee to provide certain information about the nominee and the person on whose behalf the nominee holds the partnership interest (e.g., name, address, TIN, and description of interest held) to the partnership.6 To the extent the nominee fails to provide the partnership such information relating to the other person, the nominee must then furnish to such other person a statement describing such person’s distributive share of partnership income, gain, loss, deduction or credit required to be shown on the partnership return (and any other additional information that may be required to apply other applicable provisions of the Code in connection with such person’s interest in the partnership).7 The goal is to ensure that the beneficial owner of the partnership interest has sufficient information to comply with their US tax filing obligations.
This concept of nominee reporting is incorporated into the QI Agreement by the Notice. A QI acting as a disclosing QI is generally required to provide the PTP or the QI’s nominee information relating to the person on whose behalf the QI is holding such partnership interest (i.e., in accordance with Treasury Regulation Section 1.6031(c)-1T(a)). In addition, where a disclosing QI provides the nominee statement to the QI’s nominee, the QI is generally required to obtain from the nominee a written representation that the nominee is acting as an agent of the PTP for purposes of the statement. A QI that is not acting as a disclosing QI may either provide the applicable statement with respect to the account holder to the PTP (or the PTP’s agent) or provide to the account holder that receives a PTP distribution or an amount realized on the sale of a PTP interest the applicable statement with respect to the PTP interest for which the distribution or amount realized was paid. If a QI provides the statement to the account holder rather than to the PTP (or the PTP’s agent), the QI must also ask the PTP to provide the PTP’s deemed sale information for purposes of Treasury Regulation Section 1.864(c)(8)-2 if requested by an account holder.
Events of default and material failures
The Notice modifies the definition of material failure to include situations where a QI fails to (i) withhold an amount that it was required to withhold on a payment of an amount realized from the sale of a PTP interest or on a PTP distribution or fails to provide correct information to a withholding agent or broker when QI does not assume primary withholding responsibility for either payment, or (ii) comply with the nominee reporting requirements of Treasury Regulation Section 1.6031(c)-1T with respect to one or more account holders that are partners holding PTP interests (including account holders of another intermediary when QI acts as an agent for meeting these requirements).
In addition, the Notice modifies the occurrences of events of default relating to a failure to materially comply with the requirements of Sections 1446(a) and (f). For example, the Notice proposes that an event of default includes when a QI fails to comply materially with the nominee reporting requirements with respect to account holders that are partners holding PTP interests (including account holders of another intermediary when a QI acts as an agent for meeting these requirements).
As previously mentioned, there is a practical concern that non-US investors may not have, or be able to timely obtain, US TINs despite investing in PTPs. QIs should give appropriate consideration to any risks associated with the modifications to the material failure and event of default rules in light of account holders’ documentation on file, as well as the QI’s corresponding reporting requirements pursuant to Sections 1446 and 6031.
1 See Notice 2022-23 (irs.gov).
2 A “publicly traded partnership” (“PTP”) is a partnership the interests of which are (1) traded on an established securities market or (2) readily tradable on a secondary market or a substantial equivalent. Section 7704. If a PTP has effectively connected taxable income for any year and any portion of such income is allocable to a foreign partner, the PTP must collect a US. withholding tax on actual distributions made to a foreign partner. Section 1446(a); Treasury Regulation Section 1.1446-4(e).
4 See QI Agreement currently in effect at https://www.irs.gov/pub/irs-drop/rp-17-15.pdf.