U.S. source income flows to recipients offshore through foreign financial institutions and U.S. withholding agents. The Internal Revenue Service (IRS) established the Qualified Intermediary (QI) program to improve tax withholding and reporting on such income. QIs are foreign financial institutions that contract with IRS to withhold and report U.S. tax. GAO was asked to (1) describe program features, (2) assess whether weaknesses exist in the U.S. withholding system for U.S. source income, and (3) identify any weaknesses in QI external reviews and IRS's use of program data. GAO interviewed agency officials and private practitioners and reviewed the latest IRS data on U.S. source income flowing offshore.
Recommendations for Executive Action
|Internal Revenue Service||1. The Commissioner of the Internal Revenue Service should measure U.S. withholding agents' reliance on self-certified documentation and use that data in IRS compliance efforts.|
|Internal Revenue Service||2. The Commissioner of the Internal Revenue Service should determine why U.S. withholding agents and QIs report billions of dollars in funds flowing to unknown jurisdictions and to unidentified recipients. Based on this determination, IRS should take appropriate steps to recover any withholding taxes that should have been paid and to better ensure that U.S. taxes are withheld when account owners do not properly identify themselves.|
|Internal Revenue Service||3. The Commissioner of the Internal Revenue Service should work to enhance agreed-upon procedures (AUP) by requiring the external auditor to report any indications of fraud or illegal acts that could significantly affect the results of the review. Under current AUPs, the external auditor is required to report whether, based on information from the QI or its own information, the QI is in material violation of, or is under investigation for violation of "know your customer" rules applicable to the QI. IRS should direct the head of the QI program office to expand this reporting requirement in the QI contractual agreement to require the external auditor to report any indications of fraud or illegal acts encountered while performing AUPs that could significantly affect the results of the review. This would give the QI program office the information necessary to pursue any indications of significant fraud or illegal acts identified during the AUP review through additional targeted procedures in phase 2 of the AUPs.|
|Internal Revenue Service||4. The Commissioner of the Internal Revenue Service should require electronic filing of forms in QI contracts whenever possible, thereby reducing the need to manually process data reported from abroad. Further, IRS should invest the funds necessary to perfect these data.|