IRS releases transition rules for new withholding requirements.

• Author: Sair, Edward A.

On Jan. 8, 2001, the IRS published Notice 2001-4, which contains transition rules applicable to the new withholding regime under Sec. 1441 et. seq., that took effect on Jan. 1, 2001. The transition rules substantially ease the timing requirements for required documentation under the new rules, and should permit many withholding agents and foreign intermediaries to comply more timely and accurately.

Generally, the new withholding regime draws a distinction between beneficial owners of income and intermediaries, with different rules applicable to payments by U.S. withholding agents to each. An intermediary can also enter into an agreement with the Service to be a "qualified intermediary," which allows the use of simplified withholding rules.

The transition rules include the following significant provisions:

* Foreign intermediaries that have applied for qualified intermediary (QI) status, but whose applications have not yet been finalized by the IRS, may function as QIs for six months following the date their application is submitted (or June 30, 2001, whichever is later). The Service will issue "QI-EINs" to all applicants in order for them to properly complete Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding. Withholding agents will be able to rely on an assertion of QI status (without the need to inquire whether QI status is presumed under the transition exception or is final) unless they know (or have reason to know) that the assertion is false.

* Documentation transition rules will allow QIs to use the withholding rate pooling method of reporting to U.S. withholding agents prior to obtaining the required documentation from the ultimate beneficial owners for the first year of the new QI agreement. This will be implemented via the required external QI audit. Under the transition rule, the Service will not audit the QI's first-year practices if the QI is in "substantial compliance" with the requirements during its second year and "all but an insignificant number of its accounts" have proper documentation. (QIs not in substantial compliance by year two will be subject to retroactive penalties for underwithholding.)

* QIs will be allowed to treat the beneficiaries of a foreign simple trust or the grantors of a foreign grantor trust as direct account holders (and thus include them in the "pooling" system) if:

1. The QI is required under its country's...