Evaluating long-distance promises made to Uncle Sam
September 01, 2017
More than 20 years ago a bargain was struck between financial intermediaries, investors and the US government establishing an innovative gateway for investing in US capital markets called the qualified intermediary (QI) program. The QI program was revolutionary in allowing a financial institution to provide reductions in US tax on investment income and reduce compliance complexity for an investor by signing a binding contract to police both tax evasion and aggressive avoidance on behalf of the US tax authority. Approximately 10,000 financial institutions have signed up as QIs to provide this essential service to their customers.
The QI program has shown its age in recent years: financial product innovation, flaws and limits in the design of the program, compliance failures by participants and potential misbehaviour identified by whistle-blowers required the US government to reconsider and refresh the agreement. To avoid a "tick-box" compliance approach in relation to review procedures, the revised agreement largely leaves the satisfaction of compliance obligations to the discretion of an appointed Responsible Officer (RO) who is personally liable for the QI compliance framework. The RO is any officer of the financial institution with sufficient authority to execute the agreement, which itself is 159 pages long with multiple cross references to complex US tax law, regulation and practice. This suggests a lot of weekend reading for an RO that is not familiar with US taxation and information reporting rules.
The RO must assess the design and operational effectiveness of the QI compliance program and make a certification to the US government about the degree to which the financial institution is compliant. While some elements of the compliance certification are mechanical, objective requirements that can be assessed by an independent auditor, other elements are behavioural, cultural, operational and ultimately subjective in nature relating to the adequacy of, inter alia, policies, procedures, reporting systems, and training programs. Both subjective and objective elements are to be assessed and certified to the IRS by 1 July 2018 (this date may vary). Given the limited time to assess compliance, the following activities should be considered by ROs for this autumn:
- subscribe for tailored Responsible Officer training to understand obligations, US tax rules and industry best practice;
- conduct a QI program governance/delivery risk review which evaluates compliance with new technical developments, reviews policy decisions, assessesthe affect of any staff turnover responsible for compliance, determines whether personnel have sufficient knowledge of the requirements, ensures there is traceability from policies and procedures to the agreement and probes the extent to which Foreign Account Tax Compliance Act (FATCA) compliance has been appropriately linked to QI compliance;
- review the key risks (e.g., material failures such as penalties or sanctions imposed by a regulator in relation to compliance with AML/KYC procedures) and controls associated with the QI compliance program for design and operational effectiveness;
- conduct a compliance review in advance of the audit, including sample checking customer files for completeness, reporting, withholding and reconciling payments (received in and paid out); and
- where relevant, engage in a compliance program bench-marking exercise.