QI: 2023 Year Wrap-up and Update

Another eventful year is about to be over, which means it is time for us to take a look back at all that happened in the Qualified Intermediary space this year and to inform about what is going to happen next year.

2023 QI Agreement

The new Qualified Intermediary (QI) Agreement (Notice 2022-43) has been effective since January 1, 2023. We have already informed in detail about its contents, but would like to highlight the following additional key points:

• Renewal Process: The renewal of the QI Agreement is not automatic and requires IRS approval. It is crucial to regularly check the status in the QI/WP/WT Application and Account Management System (QAAMS) to ensure it is marked as "Approved." If the status changes to "Pending," the QI should have been contacted by the IRS. If not, we advise contacting the IRS to make sure no correspondence was lost.

• Annual Reconciliation Requirement: Under the new QI Agreement, QIs are required to submit an annual reconciliation along with their periodic certification. Importantly, as recently informed by the IRS, this annual reconciliation will be mandatory for each year of the three-year certification period, not just for the 2023 tax year. For QIs whose certification period ends in 2023, this means the reconciliation requirement also extends retroactively to cover both 2021 and 2022, in addition to 2023.

• Periodic Review Report Submission: Furthermore, the new QI Agreement added the requirement that QIs that are not eligible for a periodic review waiver must upload a copy of their periodic review report along with their QI Periodic Certification.

• Changes in Waiver Eligibility for QDDs: There are new criteria for waiver eligibility from the QI periodic review. QIs acting as Qualified Derivative Dealers (QDDs) are eligible for waivers only until certification periods ending in 2024. For certification periods covering tax years beyond 2024, QDDs will not be eligible for the waiver. This means the last certification period of a QDD which will be eligible for a periodic review waiver is the period covering years 2022-2024.

Update regarding the use of Transmitter Control Code (TCC)

In our previous newsletters, we highlighted the IRS's introduction of the new Information Returns (IR) Application for Transmitter Control Code (IR-TCC), which supersedes all former methods of requesting a TCC or accessing the FIRE system. We noted significant challenges faced by non-U.S. individuals and entities, such as Qualified Intermediaries, particularly due to the need for a U.S. tax identification number under the new system.

To mitigate these challenges, the IRS has implemented some measures of relief, some of which we have already discussed previously. Newly, they have now confirmed that existing FIRE TCCs, held by non-U.S. persons and used for filing Forms 1042-S and 1099, are now automatically migrated to the new IR-TCC system. These TCCs will remain valid and accessible until the earlier of two dates: August 1, 2028, or the decommissioning of the FIRE System (which is set to be replaced by the upcoming IRIS - Information Returns Intake System). This development requires no additional action from current TCC holders.

In summary, this news has the effect that the measure implemented by the IRS to grant an access extension to existing non-U.S. TCC holders is confirmed to be temporary. The limitations we discussed will therefore continue to be a challenge in the future for non-U.S. filers.

Electronic Filing of Form 1042

Regrettably, the complexities associated with electronic filing requirements extend beyond just the 1042-S forms. On February 23, 2023, the IRS issued final regulations outlining electronic filing mandates for specific returns and related documents. These regulations dictate that financial institutions will soon need to electronically submit Form 1042 through the Modernized e-File (MeF) platform. This requirement will apply to fiscal years concluding on or after December 31, 2023. In practical terms, this means that the first electronic filing of Form 1042 will be obligatory for the tax year 2023, with a due date of April 14, 2024 (or September 15, 2024, after extension). This development will have a considerable impact on all QIs.

Furthermore, it's important to note that the electronic filing mandate encompasses not only Form 1042 but also various associated forms and schedules. These include the forms 1042-S, which are issued by upstream withholding agents to demonstrate withholding tax credit and the Schedule Q. All of these forms must be submitted electronically in XML document format. Form 7004 for requesting a filing extension can be submitted electronically or on paper.

The option to physically submit Form 1042 will no longer be available, unless a Qualified Intermediary (QI) obtains a waiver exempting them from mandatory electronic filing.

Similar to the challenges presented by the IR-TCC system, there are notable hurdles for QIs in gaining access to the MeF platform. Notably, registration with MeF again requires an individual U.S. Taxpayer Identification Number (TIN). Additionally, the MeF system is designed primarily for third parties filing on behalf of taxpayers (so-called "electronic return originators"). Consequently, it's highly probable that most QIs will need to engage a third party to file their Form 1042 on their behalf.

In response to this challenge, we are actively developing a solution that will enable us to function as an electronic return originator. We anticipate providing more updates on this matter soon, and we encourage all interested parties to subscribe to our newsletter to stay informed on the latest developments.

Non-U.S. Brokers and New 1099-DA Reporting Regime

On August 25, 2023, the IRS released Proposed Regulations concerning the Sales and Exchanges of Digital Assets by Brokers intended to take effect on or after January 1, 2025. These regulations impose specific documentation, withholding, and reporting obligations on digital asset brokers in relation to transactions carried out at digital asset kiosks located outside the United States.

Primarily targeted at U.S. digital asset brokers, these regulations may also extend to non-U.S. brokers if certain criteria are met, when there is an indication that a transaction is conducted within the United States. Such criteria are defined by the presence of specific indicators within a customer's Anti-Money Laundering (AML) or other account information, including:

1. When a customer's communication with the broker is associated with an IP address or other electronic address indicating a location within the United States (!).

2. If a customer is classified as a U.S. person in the broker's records or possesses a permanent residence address, mailing address, current U.S. telephone number (without any non-U.S. telephone number) in the USA.

3. If cash is disbursed to the customer through a transfer of funds into an account located within the United States or an account linked to a U.S. bank or financial institution.

4. When a customer has deposited digital assets into their account from a digital asset broker that the broker knows or believes to be based or connected to the United States.

5. If a customer's place of birth is in the U.S.

Should the presence of these indicators not be rectified through the acquisition of additional documentation confirming a customer's non-U.S. status, non-U.S. digital asset brokers could be obliged to report the transaction through Form 1099-DA reporting.

It's noteworthy that the proposed regulations explicitly encompass non-U.S. digital asset brokers within the scope of these new reporting requirements. However, the exact applicability of these requirements to non-U.S. brokers remains uncertain due to the considerable volume of public comments that have been submitted, potentially influencing the finalization of these rules. Additionally, the United States is likely to participate in the Crypto-Asset Reporting Framework (CARF) regime introduced by the OECD, potentially leading to a harmonization of the 1099-DA reporting regime with CARF in the future.

In any case, Swiss and other Non-U.S. digital asset brokers i.e. crypto-asset "providers" (whether they are QI or not), should monitor these developments closely to ensure that they comply with all potential filing requirements.

Changes in Double Tax Treaties with the USA

On July 15, 2022, the U.S. Department of the Treasury announced that the Double Tax Treaty between the United States and Hungary would cease to be effective starting January 1, 2024.

The termination of the double tax treaty will have implications for Hungarian residents. Previously, they may have been able to take advantage of reduced tax rates on dividend and non-portfolio interest income under the treaty. With the treaty's termination, these residents will lose access to these reduced rates. Therefore, starting from January 1, 2024, all Hungarian resident account holders will be subject to the standard U.S. withholding tax rate of 30%. It is essential for QIs to ensure that the tax rate for Hungarian residents is adjusted to 30% from January 1, 2024 on.

It is important to emphasize that this change does not apply uniformly to all types of income. Some income types, which were previously subject to reduced tax rates or exempt from withholding tax under U.S. internal tax law (such as portfolio interest, which is generally tax-exempt), will still be eligible for these reduced rates or exemptions after January 1, 2024.