The Impact and Challenges of 1446(f) for Tax Operations in 2021?

How does 1446(f) Regulation Impact Tax Operations in 2021?

With 1446 (f) still set to become effective on the 1st of January 2021, there is still so much speculation surrounding the new 1446(f) regulations, especially around how tax operations will be impacted by 1446(f) and what are the possible challenges that lie ahead for tax operations teams? 

These challenges may include having to perform audits and modify the following existing processes to accommodate for the new section 1446(f) regulation:

• Due Diligence processes

• Withholding processes

• Reporting processes 

Although the IRS has released pending guidance, from an industry stand point, participants are still waiting on a few items that impact the industry’s ability to comply with the final 1446(f) regulations. These items include the following:

• New tax certification forms (Forms W-8) and related form guidance

• Language relating to modifications of the qualified intermediary agreement

• Potential changes to Form 1042-S and instructions

How can Tax Operations start to prepare for 1446(f)?

With only months to update systems to enable compliance and issues of trying to establish a process for the collection of documentation and withholding for DVP transactions for the first time.Tax operations will have a small window to implement changes.

Preparation to implement changes to both systems and process is particularly challenge as-yet-unreleased updates will all be needed to implement the new broker PTP withholding and reporting rules and apply to transfers that occur on or after January 1, 2022 for financial accounts, brokers, custodians, and other financial institutions focusing on PTP withholding. Also, there is no exception for delivery versus payment (DVP) transactions. This raises the issue of potential increase in failed trades.

We then have the updated forms - in particular Form W-8IMY for QI roles and U.S. branch responsibilities, updated instructions for Form W-8BEN/BEN-E section 1446(f) election. Also will there be an election for Form W-8ECI foreign dealer U.S. branch operations become affected? You also have to consider the changes for 1042-S also with the updated instructions to facilitate the new section 1446(f) reporting.

Industry wide, Tax Operation will face a number of considerable challenges due to having less time to implement Section 1446(f) for due diligence, withholding and reporting. Let’s delve deeper into each of these areas of concern:

Tax Due Diligence and Re-solicitation of W-Forms

• The certification for making a claim for benefits under an income tax treaty, this meaning that the instructions to the form will be updated to include the information required for a valid treaty claim on the gain realized upon the transfer of a partnership interest, supported by a Form W-8BEN or Form W-8BEN-E.

• A broker or customer is a U.S. person (as documented by a Form W-9), certifications that are provided directly by the partnerships or Forms W-9 from the transferor.

• Foreign dealers operating through a U.S. branch that provide a Form W-8ECI, specifically, a transferor will be exempt from withholding if it provides the broker a valid Form W-8ECI certifying that the transferor is a dealer in securities and that any gain on the transfer is effectively connected with the conduct of a U.S. trade or business without regard to the provisions of section 864(c)(8).

• Where the transferor of a PTP interest is a foreign partnership, the regulations allow a broker to withhold on the “modified amount realized” rather than the full amount realized on the transfer Form W-8IMY, withholding statement, and certifications of U.S. status) provided to the transferee.

Withholding Obligations on PTPs

• Institutions will potentially have to implement a new withholding regime on gross proceeds paid to foreign persons and reporting. Institutions may also need to potentially withhold twice on the same distribution from a PTP. 

• Payments to Qualified Intermediaries (QIs) that assume withholding responsibility on 1446(f) transfers and U.S. branches treated as U.S. persons for this purpose are not subject to withholding. 

• There is a requirement for Documentation Due Diligence, and where withholding may still apply, you may be required to provide an Exemption certificate.

•  Brokers face difficult issues trying to establish a process for the collection of documentation and withholding for DVP transactions for the first time. Entities will be required to pass up documentation from underlying payees to an upstream withholding agent that will perform the withholding based on the documentation provided and will report directly to the payee.

Reporting Requirements under 1446(f)

• QIs will be able to complete their own Form 1042-S reporting with respect to amounts subject to withholding under 1446(a) or 1446(f) on a pooled basis to the same extent generally permitted under the QI agreement for other purposes rather than issuing Forms 1042-S to each customer. 

• The QI Agreement will incorporate the requirements for nominee reporting of PTP interest. The regulation also mentions that the broker’s Form 1042-S reporting should be completed on an aggregate basis for each transferor. 

• The IRS intends to update the Form 1042-S instructions accordingly. Additionally the IRS have confirmed that a foreign partnership that has been withheld upon by a broker for section 1446(f) purposes will be required to attach a Form 1042-S received from the broker in order to obtain a credit against its liability under section 1446(a).

Industry wide Tax Operations will need to act fast! As mentioned with only months to update systems to enable compliance and issues of trying to establish a process for the collection of documentation and perform Due Diligence, Withholding and Reporting under 1446(f). Tax Operations will need to prepare as best as they can.

How can TAINA help you be proactive in 2021?

At TAINA we continue to help support clients and will lobby for additional relief to implement new validation and processes to comply with changes. The TAINA Validation Platform can also help you meet your 1446(f) requirements by providing a fully automated, flexible system for tracking events, collecting withholding certificates and managing withholding.

If you have any questions about the final 1446(f) regulations and would like to have a chat about them please contact me at [email protected]or to book a CRS, FATCA or QI Compliance digital coffee chat with me directly and see how we can help  click here. 

To find out more information about our the TAINA Platform and our exclusive 1446(f) offering click here.