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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.

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Recommendations for Executive Action

Agency Affected Recommendation Status
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.
Closed - Not Implemented
IRS attempted to measure the accuracy of the self-certified documentation, including sampling Forms W-8BEN during an examination of Forms 1042 and 1042-S. IRS found this approach very difficult as there was very little information to measure against. We had hoped that IRS would compute the percentage of cases in which U.S. financial intermediaries were relying on self certified documentation from foreign investors without direct interaction with the person. IRS then could have and then focused its compliance efforts on those institutions where a high percentage of cases involved such self certified documents or involved significant dollars. Rather IRS chose to look generally at the accuracy of self-certifications. Thus IRS's approach has not been the systemic identification of non-compliance. IRS told us that they have not looked for patterns involving institutions reliance on self certified documentation, but instead they have looked to make sure the institutions had checked the boxes on the forms.
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.
Closed - Not Implemented
IRS reviewed a sample of paper Forms 1042-S to understand the problem relating to blank entries in the "Recipient Country of Residence for Tax Purposes" box and "Unknown" in the "Recipient's Name" field. IRS determined that a significant part of the problem with paper documents was that taxpayers were putting the address and country in same box and leaving the country box blank. IRS has met with bankers and withholding agents to discuss its concerns with a high format error rate involving the electronic transmission of data. IRS officials stated that they have not taken any action to recover amounts identified as having not been paid in the sample of returns they reviewed. Instead, they have used the information gathered from their review to identify examples of under withholding to help guide future audit selection.
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.
Closed - Not Implemented
IRS issued Announcement 2008-98 on November 3, 2008 which required external auditors to report to Qualified Intermediary Program (QIP) staff any material failure of internal controls uncovered during an audit of a QI. Additionally the announcement requires QIs to associate with a U.S. accounting firm. However, in an e-mail on June 27, 2012, Thomas Chillemi of IRS said that Announcement 2008-98 was not implemented. He said that next year will be the sunset of the QI program because of FATCA and there there will be no QI external audits.
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.
Closed - Not Implemented
IRS chose not to make use of the contractual nature of Qualified Intermediary (QI) program. Instead they implemented a procedure to include Form 4419, Application for Filing Information Returns Electronically, in all QI applications and renewals. By not contractually requiring electronic filing and continuing to permit paper filing of the forms, IRS runs the risk that some Form 1042-S data may not be transcribed and included in the CTW database in years were funding is not allocated for transcribing and perfecting these data.

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