NRIs may find it difficult to invest in India despite Fatca : The Act could also tighten the noose around resident Indians who have undeclared assets in the US

India and the US recently signed a tax information sharing agreement that will facilitate exchange of information between the two countries, beginning October.

Foreign Account Tax Compliance Act (Fatca) was enacted by the US government in 2010, as part of the Hiring Incentives to Restore Employment (HIRE) Act. Fatca requires all foreign financial institutions (FFI) to report information about financial accounts held by the US taxpayers (US citizens and US tax residents) to India’s Central Board of Direct Taxes (CBDT), which, in turn, will share the information with the US Internal Revenue Service (IRS). Fatca even makes it mandatory for CBDT to share information about earnings of non-resident Indians (NRIs) located in the US from sources in India to the IRS.

Fatca covers the entire banking value chain of the US clients with offshore accounts and requires a new and extended information and reporting system.

It is the obligation of the individual to ensure that ‘true and accurate’ returns and forms are filed with the IRS on time so as to avoid penalties or even criminal prosecution. Individual Americans were already required to file a yearly report called Foreign Bank Accounts Report (FBAR) about their foreign accounts to the Department of Treasury. Fatca adds additional reporting requirements for individuals. In addition to FBAR, they are now required to report their foreign accounts and specified assets as part of their tax returns. This applies to all US citizens/tax residents, and the source of income doesn’t matter.

Under this inter-governmental agreement, Indian financial institutions will have to reveal information about the US taxpayers to the revenue department which would be passed on to the US tax authorities. With Fatca in place, Reporting Financial Institutions (RFIs) of both countries shall be required to report the Reportable Accounts (RA).

Reporting financial institutions

Reporting Indian Financial Institution (RIFI) includes banks, custodian, stock brokers, mutual funds, investment banks, private equity companies, insurance firms, and other financial service providers and intermediaries. However, certain entities such as Regimental Fund or Non-public Fund of the armed forces, Employees’ State Insurance Fund, gratuity funds and provident fund shall be treated as non-RIFIs. Reporting US Financial Institution (RUFI) shall be any financial institution resident in the US or any branch of a financial institution non-resident but located in the US.

Reportable account

A. Pre-existing individual accounts having one or more US indicia must be given closer scrutiny for the purpose of identifying whether the same is an RA. These indicia or signs include US citizenship, lawful permanent resident (green card) status, a US birthplace, a US residence address or a US correspondence address including a US post box or telephone number. Individuals could come under scrutiny for issuing standing instructions to transfer funds to an account maintained in the US or directions regularly received from a US address. Granting a power of attorney or signatory authority to a person with a US address could also land you into trouble.

B. For new individual accounts, if the self-certification establishes that the account holder is a resident of the US for tax purposes, based on the information or documents collected pursuant to the KYC procedures, the RFI shall be required to report the same.

India’s current KYC norms may not be enough to identify the US citizens and residents. So, along with account opening processes and transaction processing systems, KYC procedures will have to undergo changes for Fatca implementation.

Certain accounts are excluded from the definition of financial accounts and shall not be treated as US RAs. These include savings accounts such as Retirement and Pension Account and non-retirement savings accounts, certain term life insurance contracts, accounts held by an estate, escrow accounts and partner jurisdiction accounts.

What to report?

RFIs of both countries have to report the name, address, US TIN and account number of each specified US person. In case of custodial accounts, RIFIs shall report the gross interest, dividend, other income generated during the calendar year and gross proceeds from the sale of property to which the RIFIs acted as a custodian. In case of a depository account, gross amount of interest paid/credited shall be reported. RUFIs shall report gross amount of US-sourced dividend paid/credited and gross amount of interest paid on depository account.

Impact

US citizens and the US-based NRIs need to be more mindful while complying with their US reporting rules. Even if an income is exempt from income tax in India as per the Indian tax laws, it may not be tax-free in the US and subject to local taxes. This income should be reported to the IRS. For example, a US-based NRI has investments in shares in India and is earning dividend income which is exempt from tax in India. With the Fatca in place, he will have to ensure that he is including the same in his US tax returns since the income may be reported to the CBDT.

Given the complexities in direct reporting to the IRS, many Indian FIs had closed accounts of the US persons and were not accepting fresh investments from the US. With the Fatca in place, such Indian FFIs are expected to no longer refuse investments from US persons/NRIs. However, NRIs may still find it difficult to invest in India.

Indian residents shall be impacted with the RUFIs reporting their financial accounts to Indian tax authorities under the terms of Fatca. This information will provide more teeth for the Indian tax authorities to detect assets held by Indian taxpayers in the US. Together with the newly enacted Black Money Act, this could have serious ramifications for Indian residents who may not have reported such assets to the Indian tax authorities.