Final 2023 QI Agreement and Section 1446(f) Update

On December 13, 2022, the IRS announced the contents of the final version of the 2023 QI Agreement (Rev. Proc. 2022-43) which will be published in the Internal Revenue Bulletin on December 27, 2022. The final version of the QI Agreement incorporates most additions made in the proposed QI Agreement (Notice 2022-23). The proposed QI Agreement only contained changes related to 1446(a) and (f), about which we informed in detail in our newsletter "Section 1446(f) and New QI Agreement", but the final 2023 QI Agreement also includes additional changes and provides some relief. We will list a summary of those modifications in detail further below.

As the current QI Agreement expires on December 31, 2022, QIs will have to renew the QI Agreement and sign the 2023 QI Agreement until March 31, 2023. They will be able to do so in the QI Responsible Officer Portal (QAAMS) when the IRS updates the portal. Once renewed, the new QI Agreement will be considered retroactively in force from January 1, 2023.

In addition, on December 21, 2022, the IRS published Notice 2023-8 with which it provides (much sought-after) additional guidance for brokers to comply with the provisions of Section 1446(f). The IRS intends to amend the final 1446(f) regulations with the contents of that additional guidance.

We recommend that all readers of QIs read in particular chapter 2.3 of this information.

1. Notice 2023-8 and Section 1446(f) Relief

With Notice 2023-8, the IRS provided guidance and relief in three sections:

1. Sales of interest in non-U.S. partnerships: The Notice steers the scope of Section 1446(f) towards domestic Publicly Traded Partnerships (PTPs) by providing withholding relief to brokers on the sale of an interest in an entity that is organized outside of the United States and that trades solely on a foreign established securities market or foreign secondary market. For these entities, a broker may presume that the entity is not a PTP for U.S. tax purposes and is therefore relieved from withholding on a sale of an interest in that entity.
   We expect the IRS to precisely define the term “PTP for U.S. tax purposes” with the upcoming proposed regulation, which may very well also include certain non-U.S. entities if they are in scope. Also, the IRS intends to limit the presumption, and brokers will be required to treat the entity as a PTP for U.S. tax purposes if they have actual knowledge that it is. Once the broker knows that the entity is a PTP for U.S. tax purposes, the broker will not be allowed to presume that the entity does not have effectively connected income and will have to rely on a qualified notice and withhold in its absence.

2. Reliance on late certifications: Under the final 1446(f) regulations, brokers could only rely on certifications provided by transferors to reduce a rate of withholding if they received them 30 days before the transfer. The IRS has determined that it is appropriate that brokers rely on the sections 1441 and 1471 documentation rules, which means that brokers can rely on a certification if received within 30 days of the payment (and more, if the transferor provides affidavit or documentary evidence).

3. Short sales of PTP interests: The IRS intends to amend the final regulations to provide an exception to withholding under Section 1446(f) on a short sale of a PTP interest in most circumstances.

Especially the first relief is a significant burden reduction for brokers. Without this relief, any partnership, whether foreign or domestic, whether listed on a U.S. exchange or not, whether it invested in U.S. companies or not, would have been in scope and subject to 1446(f) withholding if it did not provide a certification on a qualified notice that it is exempt from withholding. With this new rule, brokers can presume that a foreign partnership is not a PTP for U.S. tax purposes and should therefore be able, if they do not have knowledge otherwise, to forego withholding under Section 1446(f).

2. Final 2023 QI Agreement

The changes in the final version of the 2023 QI Agreement (QIA) can be summarized in three categories:

• Changes (and some minor relief) related to the inclusion of Section 1446(a) and the new Section 1446(f), and the different roles QIs can assume when processing PTP distributions and transfers of PTP interest.

• Modifications made in relation to the Qualified Derivatives Dealer (QDD) regime, not only to incorporate the newest extension of the good-faith period, but also to integrate other types of clarifications related to QIs and QDDs processing payments under Section 871(m).

• Other types of clarifications and modifications. These will be most interesting to QIs which are neither QDDs nor are affected by Sections 1446(a) and (f).

Regarding Sections 1446(a) and (f), the relief the IRS granted in Notice 2023-8 and the 2023 QIA are not as big as expected. Especially regarding QIs planning to act as Nonqualified Intermediary for account holders without a U.S. TIN and as disclosing QIs for account holders with a U.S. TIN, the IRS specifically denied this possibility in the preamble to the 2023 QIA and confirmed that disclosing QIs will have to obtain (or at least show best effort to obtain) U.S. TINs from all account holders.

2.1 Most important changes with regard to Sections 1446(a) and (f) compared to the proposed QI Agreement

• The QIA contains relief regarding a QI’s requirement to obtain U.S. TINs from account holders by allowing the QI to obtain U.S. TINs on a “best effort” basis, if the QI can prove that they have made repeated attempts to obtain a U.S. TIN from account holders. Also, this reduces the risk of disclosing QIs’ custodians rejecting forms without U.S. TINs. The ruleset in the proposed QIA basically prevented QIs from acting as disclosing QIs because of this. The relief, however, will only affect potential non-compliance of a QI with the QIA, it does not relieve account holders of disclosing QIs from the requirement to provide a U.S. TIN and does not allow for reduced withholding rates in case of their absence.

• The IRS granted another type of relief to disclosing QIs allowing them to pass along Schedules K-1 they receive (e.g. received by custodians on segregated accounts at custodian level) to end investors, provided that the QIs include with the Schedule K-1 supplemental information (if necessary) to allow an investor to allocate amounts on the Schedule K-1 to their account.

• The QI periodic review requirements have been modified to include procedures on accounts to which a QI makes PTP distributions and amounts realized from a transfer of a PTP interest. In addition, Annex II where the QIA describes a reviewer’s sampling methodology has been significantly revised to accommodate the new Section 1446 additions to the QIA.

• The Responsible Officer certification has been substantially extended with two new certifications in Part II.A and a new Part VII where QIs acting as QI for PTP-related payments will need to certify and provide to the IRS information related to documentation, withholding and reporting.

2.2 QDD and Section 871(m) additions to the 2023 QIA

• The QIA generally retains the requirements set forth in the 2017 QIA, but some clarifications and modifications have been made.

• The IRS has included the various notices made in the past which mostly extended the good-faith period or the transitional rules into the QI Agreement, which was extended to January 1, 2025, for both QDDs and Qualified Securities Lenders (QSLs).

• The QIA continues to exclude QDD accounts from a QI Periodic Review in Annex II and continues to omit QDD’s activities in the certification. The preamble to the final 2023 QIA does confirm that this missing information is anticipated to be added to the QI Agreement “in a notice or revenue procedure that will set forth a [so-called] “rider” to include this information and any changes to the requirements of QDDs deemed necessary”.

• Foreign QDDs are confirmed to be required to file a Form 1120-F and attach Schedule Q (Form 1120-F) to the Form. The guidance has so far been ambiguous in this regard.

• The QIA now requires QDDs to specify in their withholding statement the dividends they receive in their equity derivatives dealer capacity for calendar years 2023 and 2024.

• The QIA also specifies in much detail how a QDD that is a partnership should realize the QDD requirements.

2.3 Other additions and modifications to the 2023 QI Agreement

• The specific KYC country attachments are now referenced in the final 2023 QI Agreement (QIA).

• The preamble to the QIA clarifies that the IRS may consider extending the Responsible Officer certification due date under appropriate circumstances on a case-by-case basis if the QI seeks an extension.

• There has been a significant overhaul of the Section 10 and Appendix I/II compliance requirements of the QIA, which includes, apart from the inclusion of Section 1446 mentioned above, the following:

  1. The QIA now specifies that a QI is required to submit the QI Periodic Review Report with the certification (previously the submittal was optional, and the report had to be provided to the IRS upon request).

  2. Part IV of the QI certification, where the QI provides factual information based on the results of a QI periodic review, has been overhauled and now allows to enter factual information after curing (a very welcome change).

  3. Also, a chart is to be completed by the QI in Part IV when the reviewer used the safe harbor sampling method in Appendix II for the periodic review to specify the allocation of accounts to each certainty stratum (another new term introduced in Annex II, which has been substantially renewed).

  4. Most importantly, a brand-new Appendix III has been added to the QIA. The Appendix requires a QI to upload with the Responsible Officer certification a reconciliation of all Forms 1042-S and 1042 filed during the certification period to assist the IRS in determining whether Forms 1042 and 1042-S were filed accurately. The QI will have to provide this reconciliation for the years of a certification period not covered by a periodic review (which means all three years if the QI applies for a waiver).

• Previously, a QI was required to obtain from each section 4.05 partnership or trust (so-called joint account holder rule trusts or partnerships) a certification indicating that the partnership or trust maintained a “permissible chapter 4 status during the QI’s entire certification period”. The QI, as part of its certification, was required to indicate that it was provided these certifications by the partnerships or trusts. The QIA omits this requirement and now allows a QI to rely on the documentation obtained from the account holder (such as a Form W-8IMY) to determine the account holder’s chapter 4 status and is allowed to continue to rely on the documentation until a change in circumstances or until the documentation expires.

• The QIA specifies that the LOB code ("Limitation on Benefits"-Code) collected from entity account holders that request treaty benefits only needs to be reported via a Form 1042-S if the Form is recipient-specific. This requirement was already specified in the instructions to forms 1042-S and it has been reconfirmed in the QI Agreement that there is no need to create separate pooled forms 1042-S for each LOB code in the future.

• The QIA now allows QIs to treat an account holder’s address which is subject to a hold mail instruction as permanent residence address, provided that the QI has other documentary evidence on file that supports the person’s claim of foreign status or, for a claim of treaty benefits, the person’s residence in the country where the benefits are claimed.

• The QIA now specifies a time limit in which account holders subject to overwithholding can request from a QI a recipient-specific Form 1042-S to file a tax reclaim which is generally two years after the overwithholding occurred (or three years in the case of a PTP distribution or an amount realized from a PTP transfer).

• The QIA substantially revises and clarifies rules applicable in the case of a merger of QIs or termination of the QI Agreement, which includes rules related to the final certification and periodic review.