Beneficial Owners and Taxation

The primary focus for resolving tax disputes for assesse with multi-jurisdictional presence is going to be the beneficial ownership and economic nexus.

Generally, the tax relief w.r.t. interest, dividend, capital gain, royalties and fee for technical services in the source country, can be claimed by the ‘beneficial owner’. Who is the beneficial owner? How is the beneficial owner distinguished from the legal owner.

A legal owner is the person whose name appear on the legal documents of an asset as the owner. The person who is entitled to the economic benefits of the asset is the beneficial or economic owner. The legal owner and the economic owner can be two separate and distinct persons. If it is so, the legal owner holds the economic interest in the asset on trust for the beneficial owner. For example, in case of land, its beneficial owner will have a right to the income from the property and a right to the proceeds of sale of the property. The benefits arising from the asset are enjoyed by the beneficial owner. As a corollary, the beneficial owner takes decisions related with manner of use and how the returns from the property should be utilized. Though the legal and beneficial owner may be the same person. But this is a question of fact in each case.

In a recent case (Case no. 2C_364/2012, Federal Tax Administration v. X. _____ Bank (Judgment dated May 05, 2015)), Swiss Supreme Court observed that the power of disposal is classified as the key element of beneficial ownership. Applying is to the facts of that case the Court observed that the dividend recipient is then the effective beneficial owner if it may fully dispose over the dividend and enjoy the full benefits thereof, without this use being restricted by statutory or contractual obligations. The Court framed that rule that greater the interdependence between the income and the obligation to pass it on, the weaker the beneficial ownership.

Such rulings are likely to become global trend where emphasis is put on substance over form to prevent treaty abuse and to implement OECD’s Base Erosion and Profit Shifting (BEPS) guidelines. India has committed to implement BEPS and its General Anti Avoidance Rules (GAAR) are going to be implemented from the financial year 2017-18. In view of this, it is critical to have business structures and relationships which are at arm’s length with commercial substance and are not likely to be characterized as abuse of domestic taxation provisions.

Yogesh Kumar

Yogesh_ub@hotmail.com

Masala Bond requires additional masala for lenders to get excited

Masala bond is an additional way of borrowing for Indian entities from foreign markets. The distinctive feature of these bonds is that the bonds are Indian Rupee denominated and so the exchange rate risk is carried by the lender and not the borrower. This particular feature was instrumental in allowing for various relaxations available to borrowers with respect to use of funds raised through masala bond.

The Indian borrowers see this as an opportunity to borrow money in foreign markets at the prevalent market rates. For them, the bonds have the potential to reduce the cost of borrowing as well as provide the flexibility to use the money. The driving force for the lenders to buy these bonds is the ‘India story’.

However, the lenders have a different perspective. Irrespective of ‘India story’, India carries a higher risk and they seek risk adjusted return. Secondly, the lenders have to hedge the exchange rate risk as Indian currency is showing only a downward trend for quite some time. Further, the secondary market for Rupee denominated bonds yet to develop. Form lenders’ perspective there are quite a number of risks and the return on the masala bonds should take care of this. These and related parameters are likely to enhance the cost of borrowing for Indian entities than their expectation.

Another fundamental issue faced by lenders pertains to the option to invest through FPI route. For both, the Masala Bond as well as FPI route the lender carries the exchange rate risk. Further, FPI route may provide withholding tax advantage in case the investment is through countries whose DTAA with India provides this advantage. Further, they have the opportunity to tap the higher domestic interest rates and also provides the much needed liquidity in India. 

Masala bonds are likely to be used by investors unable to use the FPI route and are sold on Indian story. However, to attractive them, some level of balance to be reached w.r.t. the rate of interest. A middle ground between the foreign market interest rates and the Indian domestic rates have to be found.

yogesh_ub@hotmail.com

FATCA and Non Resident Indians (NRIs) in USA

That Foreign Account Tax Compliance Act (FATCA) is in place and active since 2014 is a well-known fact. Many NRIs living in the US have been rudely woken up to the new environment where on the one hand they are no longer welcome in India to invest their money while before FATCA, investment by NRIs were greatly sought after and also the possibility of disclosure of all their investments in India to IRS in US. Hence, it becomes imperative for US based NRIs to have a clear understanding of the impact on their tax liability due to the exchange of information as per the provisions of Inter-Government Agreement (IGA) signed by India with USA to give effect to Foreign Account Tax Compliance Act (FATCA). 

The practical issues which any NRI residing in USA has to deal with in view of FATCA requires a cogent analysis. Although the popular understanding appears   as if certain tax related regulations have changed requiring US resident NRIs to pay additional taxes, the fact is there is no additional tax imposed. However, US resident NRIs will not be able to hide their India sourced income for fulfilling their US tax obligations.  This means that if they were not paying their taxes on this income, now they will have to pay and there may be some penalties for past non-compliance.

A background on FATCA and the manner of its implementation will be helpful to plan for tax related impact. FATCA is an Act passed by US legislature and is enforced on financial institutions across the world. In this way, it is a regulation which has extra-territorial application.  FATCA is supported by bilateral agreements (Inter-government agreement, the “IGA”) which USA has entered into with each country. USA has entered into IGA with India and is effective now.

USA lawmakers realized that the income earned by US residents (US citizens or resident aliens) outside the US does not get disclosed to Internal Revenue Service (IRS) and therefore escapes from tax. Further, most of this income arises in accounts maintained with financial institutions (as defined in FATCA / IGA).

These facts provided the framework for the FATCA legislation. The objective of FATCA is to ensure that all US residents pay their tax dues to Uncle Sam. No US tax resident should be in a position to hide his/her income from Uncle Sam. To implement this objective, US IRS intends to collect information on the global income earned by each US residents.

The FATCA / IGA mandate that each entity irrespective of its legal status and jurisdiction (excluding US entities) should categorize itself as:

·            Foreign Financial Institution (FFI) or

·            Non Foreign Financial Enterprise (NFFE), Active or Passive

An entity which identifies itself as FFI domiciled in a jurisdiction has the following KYC and reporting activities:

1.       Identify its accounts holders who have any connection with USA.

2.         At the time of opening any new account, to ensure whether the person opening the account has any US connections.

3.       In case of US connections, to collect certain specific information like name, address, U.S. TIN, account number, the account balance or value at the end of the relevant calendar year or immediately before the closure, of the account holder for the year 2014. For the year 2017 and subsequent reporting providing of U.S. TIN will be mandatory.

4.       For 2015 onwards additional information w.r.t. custodial account, the gross amount of interest, dividend, gross amount of other income generated. For depository account the gross amount of interest paid or credited to the account.

5.       For the year 2016 onwards additional information w.r.t. custodial account the total gross proceeds from the sale or redemption of property paid or credited to the account.

6.       At the end of each financial year i.e. as on December 31, find the value of the money / securities etc. maintained with the account.

7.       If the value maintained with the account is above certain threshold value (generally USD 50,000), report the above mentioned details of the account to the local tax authorities.

The local tax authorities will collate the information received from all the financial institutions in its jurisdiction. This information will be shared with US IRS within a defined timeframe.

It would be appropriate to add few details at this stage.

Foreign Financial Institution covers entities like custodial institutions (e.g. holds financial assets like custodian banks, depositories, brokers); depository institutions (holds deposits like banks); an investment entity (Brokers, mutual funds, investment manager / portfolio manager) and specified insurance company. The threshold value identified for reporting for accounts is account value exceeding USD 50,000 with few differences between pre-existing and new accounts w.r.t. cash value insurance.

The types of accounts whose information is to be reported are checking, saving, commercial, certificate of deposit, investment certificate, depository accounts, brokerage account, equity or partnership interest, debt interest, settlor or beneficiary of a trust, insurance contract, etc. It is immaterial whether the account is held directly or through agent, nominee, investment advisor, intermediary etc.

Certain types of accounts like retirement and pension accounts, term life policy type of insurance are excluded from the definition of Financial Account. Brokers, investment advisors, portfolio managers are treated as non-reporting FI.

All Indian financial institutions (FI) will classify their account holders having US indicia and those without US indicia. Account holders with US indicia are likely to be contacted by the FI to seek their TIN and other information which is to be reported to the US IRS. Further, the FI will seek some declaration from the NRI account holders wherein the account holder agrees to the FI sharing the information with IRS.

An NRI holding a Non-Resident (Ordinary) bank account and earning interest on such savings and term deposit accounts pays tax deducted at source on the interest earned in India. Under the DTAA provisions, the credit for such tax paid in India can be claimed in the US income tax return.

On the other hand, interest earned on NRE savings and NRE term deposits is not taxed by Indian Income tax authorities. The interest earned in this account / term deposit is something the NRI should disclose to IRS before the information flow takes place through exchange of information.

However, interest income earned on PF and PPF is not subject to income tax in India and will not be reported by the FIs as these two accounts are not classified as financial accounts. Interest income from other investments like Post Office Monthly Income Scheme, National Savings Certificate, Kisan Vikas Patra, corporate bonds, treasury securities etc. again will be subject to income tax in India as well as in US and should ideally be disclosed in the US income tax return.

Investment made in equities and mutual funds and the capital gain realized on the sale of these investments will be subject to tax in India as well as in the US but tax credit will be available for the tax paid in India.

The income derived from immovable property held in India is taxable both in India and the US. First tax in India is to be paid as withholding tax by the tenant/buyer and this income is included in the US tax declaration.

It is relevant to note that the account value will be provided to the US IRS as on the end of the calendar year where threshold value is more than USD 50,000.

yogesh_ub@hotmail.com