The Internal Revenue Service (IRS) in the US has drawn the offshore fund management industry into it...
The Internal Revenue Service (IRS) in the US has drawn the offshore fund management industry into its fight against tax evasion by threatening uncooperative intermediaries with a tax penalty of 31% on dividends and interest payments.
From 1 January 2001, the IRS will demand the names of beneficial owners of income and interest from assets. Anonymity can only be maintained if the liability is calculated by a qualified intermediary (QI).
Every company in the chain between the withholding agent (who processes the US transaction) and the beneficial owner is an intermediary. Intermediaries deemed suitable by the IRS can sign an agreement and become a QI, who then has the power to determine the correct rate payable by the withholding agent to the IRS without revealing the beneficial owner.
Up until now, fund management groups were happy to keep their heads below the parapet while custodians worked out the implications of the new rules. The effect on investment managers can be minimised so long as it clear who the beneficial owners are. In most cases, the funds themselves are regarded as the beneficial owners of their assets, or in the case of trusts, the trustees. However, there are cases in which there is more than one intermediary: for example, when investment managers use nominee companies. This could make compliance with the regulations more complex.
Travis Barker, Senior Manager Tax & Legal Services at PriceWaterhouseCoopers, said: "Why it's so striking is because the onus has been put on the intermediary rather than the investor. If it is determined that the QI was wrong, then it is potentially liable, so being a QI carries quite a big risk."
With the onus on identifying beneficial ownership now on the QI, how far will intermediaries be expected to investigate to determine final ownership?
Jeremy Arnold, a partner in law firm Withers, says: "One interesting point is: how far do these rules go? For example, how does it extend to trusts and foreign companies?"
If it extends far enough, then intermediaries might find themselves acting as agents for the IRS. One way to avoid this extra risk and responsibility would be for an intermediary to use a third party QI to satisfy the IRS. But many intermediaries, particularly custodians, will not see this as an ideal solution, firstly, because of the extra cost of bringing in the third party and secondly, the fact that valuable customer information will have to be released.
Barker said: "If a company goes for the role of qualified intermediary, it carries administrative overheads as well as added risk, but it holds onto all customer data."
Arnold said: "I think there is going to be a flushing out process with groups taking a good look at their clients. If they have got slightly embarrassing US tax affairs, they won't be welcome." For example, he said: "All the banks are going to have to review their accounts to see if they are dealing with any US persons."
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