IRS: Get Your Data Right on FATCA and QI Certifications (Or Else)

The US Internal Revenue Service is turning tax operations and compliance departments into data and paperwork geeks when it comes to meeting their requirements for FATCA and QI.

Did your tax operations department withhold the correct amount of tax for the right account and file the form correctly by deadline? That’s what an IRS auditor will be asking when he or she looks into your paperwork and underlying data, warn panelists at a recent internatinal tax withholding and information event in New York.

Tax operations managers are at the front line of complying with FATCA and QI requirements because they are responsible for translating regulatory guidelines provided by corporate tax and tax compliance departments into practical workflow. The worklow is data-intensive, related to the process of determining which systems, which data, and how data is collected and validated before the withholding tax is calculated and deducted.

Keeping secrets about any snafus isn’t advisable, because the IRS has a good idea of what you have done wrong before it knocks on your door. That’s after it sends your firm a Dear John letter saying it is worried about whether you did your work correctly. Apparently, the IRS has been sending out quite a few of those letters to US withholding agents — banks and broker-dealers– concerning FATCA, short for Foreign Account Tax Compliance Act.

The consensus of panelists and attendees at the withholding tax event hosted earlier this month by Loscazlo Institute, a unit of Kaplan Financial Education: fess up if you can’t comply with the IRS’ certification requirements and explain what you will do to correct the situation. Promptly. And if you don’t want to find yourself the target of an IRS audit you had better figure out how to find all the necessary documentation and data proving you fulfilled the IRS’ requirements.

Adopted in 2010, FATCA’s goal is to ensure foreign financial institutions help Uncle Sam catch US persons evading US taxes. Investors whose countries have sighed Model 1 intergovernmental agreements with the US Treasury, the IRS’ parent, will have an indirect relationship with the IRS. They must disclose any US persons and account information to their local tax authorities to pass along to the IRS.

Institutions whose countries have signed Model 2 intergovernmental agreements with the US Treasury must file the same information directly with the IRS and appoint dedicated responsible officers (ROs) to sign off on the paperwork. Although only a handful of countries — such as Switzerland and Japan– have signed Model 2 agreements, many global banks may be following Model 2 requirements if some of their offices fall in the list of Model 2 countries.

The designation of QI, short for qualified intermediary, allows foreign financial firms to avoid disclosing the names and account information of foreign investors in US securities to upstrean US paying agents. All they have to do is bucket non-US investors in different categories of withholding tax. Financial firms were required to certify their compliance with FATCA by either December 15, 2018 or March 31, 2019 if they represented sponsoring entities for the 2017 tax year. They were also required to do so for their role as QIs by March 1, 2019.

IRS officials who spoke at the withholding tax event urged financial firms to review the status of their submissions to the IRS concerning FATCA and QI through separate IRS message portals. ROs will be notified by email that the IRS hasn’t received their submissions so its best for financial firms to make certain they have provided the right contact information for their ROs. In the case of compliance for QI status, the IRS is also relying on old fashioned faxes and the postal service.

Financial firms who can’t complete the certification requirements for FATCA and QI purposes face termination. It’s a lot worse than getting fired from a job which will prompt you to find another one. The IRS will end your firm’s agreement with the tax agency and in the case of FATCA a 30 percent withholding tax must be assessed on most payments of US-sourced income.

What happens if your firm makes a mistake on its certification for FATCA? Well, the IRS won’t allow you to delete or amend your certification. You have to submit a brand new one and start all over in the case of FATCA. QI submissions can be corrected, but the original submissions are not deleted, say tax operations managers.

What if the foreign financial firm no longer meets the IRS’ definition of a foreign financial institution required to comply with FATCA? The IRS will allow it to cancel its agreement with the IRS and it has six months to file a final certification.

How did financial firm fare when it came to completing their certifications? Panelists and attendees at the withholding tax event say that they did far better with QI than with FATCA certications because QI certifications started back in 2001. It is also likely that financial firms picked experienced tax operations specialists to complete their QI certifications while ROs for FATCA were more likely to be generalist legal or compliance managers.

IRS officials concede that there were some delays with FATCA certification because financial firms confused FATCA deadlines with QI deadlines. Alternatively, business lines and legal entities couldn’t get their acts together in time for their ROs to sign off on certification. Using internal audit managers, instead of external ones, proved to be an obstacle in some cases as they were unfamiliar with tax regulations.

Sending the IRS a certification of compliance naturally relies on knowing how to use the IRS portal. Surprisingly, using automated means proved cumbersome. “Our clients weren’t embracing the technology from day one as I was doing a lot of handholding, logging into the portals and helping them press the right buttons,” says Glen Lovelock, senior manager of financial services at consultancy Deloitte AG in Zurich.

Not all financial firms will be prepared to certify they are compliant with the IRS’ FATCA requirements. For those having to file “qualified certifications” the work then becomes centered on providing complete and sufficient explanations. The IRS doesn’t want to know your firm is trying to fix its shortcomings. It wants more specifics on what your firm is doing. “We spent a lot of time with client handwringing and wordmithing about what to say,” says Candace Ewell, a tax principal for global consultancy PwC in Washington DC. “Once you have made a qualified certification you are on the clock for how to improve.”

Even those who think they filed accurately had better rethink their attitude. “Financial firms can’t afford to breathe a sigh of relief thinking their work is done,” says Chip Collins, managing director and head of QI and FATCA compliance for UBS in Stamford, Connecticut. “The work is just beginning.”

Financial firms have to be concerned over potential mistakes with under-withholding when it comes to their QI documentation. The underwithholding likely was the result of poor client documentation or a technological snafu — the lack of integration between the client onboarding platform and the withholding tax platform .

In the case of complying with FATCA requirements, the key concern is irreconcilable information on Forms 1042 and 1042S which require non-resident alien and FATCA withholding tax data. When the IRS catches data discrepancies such as incorrect TINs, tax rates, payment amounts and withholding tax amounts it may decide an audit is in order.

Akin to an audit for personal taxes, an audit for investor withholding is holistic. “The IRS auditors have already done their due diligence on the financial firm in question and will want a review of the entire lifecycle from the time the customer is onboarded to the time the withholding tax is deducted from a payment and the time of reporting,” says Kevin Sullivan, head of US information reporting and advisory service for Bank of America Merrill Lynch in Charlotte, North Carolina. “Because its not possible to accomplish all of that live during the auditor’s visit, screen shots of each event are advisable to walk the IRS through.” Of course the appropriate individuals responsible for each event should be on hand to answer any questions.

The goal of the review is to conduct a fishing expedition of sorts. “The IRS’ concern extends beyond whether the financial firm made an error in withholding tax on a particular account or accounts it has identified,” says Cyrus Daftary, a principal in the information reporting and withholding group for global consultancy KPMG in New York. The IRS wants to know whether there is a flaw in the financial firm’s processes which could have caused an underwithholding in other accounts.”

Getting an early start can’t hurt. The inherent difficulty with certifying a firm is compliant is that the individual signing off on the paperwork filed with the IRS isn’t the one doing all the data gathering and validation. It’s everyone else. That means that the RO or other designated official has to rely on subcertifications or guarantees of sorts from individual business lines and legal entities. The process has often been compared to meeting the requirements for the Sarbanes-Oxley Act, a 2002 US federal law requiring senior executives of public firms to take individual responsibility for the accuracy and completeness of corporate financial reports.

Just how far down the line the subcertification must go will depend on the size of the firm. The larger the firm the more likely the subcertification is at the business line manager rather than the individual eager beaver workers.

“Financial firms must plan to complete their subcertifications way before the deadline for when their firms must submit their certifications with the IRS,” says William Sheridan, director of Tax Solutions at IHS Markit, a financial tech and information firm in New York. Indeed, gathering subcertifications appear to be one of the major obstacles to filing the right paperwork with the IRS by the designated deadlines for both FATCA and QI. The reason: there are too many cooks in the kitchen who might be relying on inconsistent standards. Each business line might have differing definitions of exactly what compliant means. They could disagree on what is a default — a smaller lapse — or a major material failure.

“Ideally, financial firms should create a single consolidated centralized unit handling FATCA and QI certifications,” says Sheridan. However, financial firms might not achieve such centralization any time soon. Consolidated reporting for FATCA at the parent level isn’t even favored because no one wants to take responsibility for the entire lot of business units or legal entities.

Not only must financial firms keep track of all their customers, accounts and withholding tax. They must also keep track of who is coming and going at the staff level. “It’s best for a single person to monitor staff changes which would affect who is the designated responsible officer or point of contact for the IRS,” says Collins. “Firms might have even registered multiple units as foreign financial institutions that must now be deregistered.”

For financial firms worried about complying with FATCA and QI compliance, panelists and exhibitors at the tax event pointed to plenty of consulting and technology solution providers. All of the major global consultancies, such as KPMG, Deloitte and PwC provide guidance on onboarding and documentation completion. IHS Markit says it offers technology and advisory services for client onboarding, document validation and withholding tax calculations to meet both FATCA and QI requirements. Dublin-based Fenergo offers client onboarding and tax form validation for FATCA while London-headquartered  Taina Tech says that its platform provides client onboarding, tax form validation, withholding tax calculation, workflow managment and a responsible officer module to comply with FATCA.

One last bit of advice from panelists at the withholding tax event: doing all the withholding tax calculations and paperwork right is great, but not at the expense of the basics. “We spent a lot of time helping clients write their policies and procedures after they had already gone through their periodic reviews,” says Ewell.