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.

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