India & US Sign Tax Information Agreement for FATCA
By Tracie Sloop Frost
On July 9, 2015, U.S. Ambassador to India Richard Verma and Indian Revenue Secretary Shaktikanta Das signed an agreement to implement the Foreign Account Tax Compliance Act (FATCA). The agreement is designed to increase transparency between the two nations on tax matters. The agreement takes effect September 30 and underscores growing international cooperation to end tax evasion.
What is FATCA?
FATCA targets non-compliance by U.S. taxpayers using foreign accounts and is quickly becoming the international standard for curbing tax evasion. The law requires U.S. persons, including those living overseas, to report their financial accounts held outside of the U.S. It also requires non-U.S. financial institutions to report details of their U.S. clients to the Internal Revenue Service (IRS).
Over 100 countries have already signed an agreement with the U.S. The Indian agreement promotes mutual information sharing, meaning that the U.S. will also share financial information on Indian residents who have investments in the U.S. with the Indian Ministry of Finance (MoF).
Regardless of whether a country signs an intergovernmental agreement with the U.S., FATCA requires foreign financial institutions (FFIs) to register with the IRS and report information about financial accounts held by U.S. taxpayers. If the FFI does not comply, the IRS can impose a 30 percent withholding penalty on U.S. payments made to the FFI. However, once a country enters into an agreement with the U.S., individual FFIs no longer have to register with the U.S. Internal Revenue Service (IRS), reducing their compliance burden.
By signing the agreement, the Indian government can shield Indian financial concerns from facing withholding taxes in the U.S. for failing to disclose the dealings of U.S. citizens and entities. The fear of U.S. withholding, and the burden of compliance, has caused several Indian mutual funds to bar U.S. residents and U.S.-based Non-Resident Indians (NRIs) from investing in their funds. Now that Indian financial institutions do not have to directly register with the IRS, that burden will lessen, as will the concern of attracting a withholding penalty.
However, removing the registration burden does not remove an FFI’s responsibility to report financial information about U.S. persons to the IRS. And, in fact, that burden is quite substantial.
How does FATCA work?
FATCA has two reporting requirements – one for individuals and one for foreign financial institutions.
For individuals, specified U.S. persons holding financial assets outside the U.S. must report those assets to the IRS, in most cases using Form 8938, Statement of Specified Foreign Financial Assets. The Form 8938 must be attached to the taxpayer’s annual tax return.
For Indian financial institutions, FATCA requires that each institution report the names, addresses, tax identification numbers, account numbers and account balances of each account holder that is a specified U.S. person. For FFIs in countries that have not entered into a FATCA agreement with the U.S., this reporting is done directly to the IRS. For FFIs in countries like India which have an agreement with the U.S., FFIs report this information to their respective governments.
Who is specified as a U.S. person?
Under FATCA, a U.S. person is defined as a citizen or resident of the U.S. (including a green card holder), a U.S. incorporated entity (including partnerships and trusts), or a non-U.S. incorporated entity having shareholding of 10 percent or more held by a U.S. citizen, U.S. resident, individual with a U.S. mailing address, or U.S. incorporated entity.
What is a Foreign Financial Institution?
FATCA defines foreign financial institutions as depository institutions (for example, banks), custodial institutions (for example, mutual funds), investment entities (for example, hedge funds or private equity funds), interests in foreign partnerships, and insurance companies that have cash value products or annuities. In general, domestic mutual funds investing in foreign stocks and securities, foreign real estate directly held, and personal property directly held are not subject to reporting under FATCA. A complete list of foreign assets that must be reported can be found on the IRS website.
Are there any exemptions from reporting requirements?
The following financial institutions are exempt from reporting under FATCA:
Most governmental entities;
Most non-profit organizations;
Certain small, local financial institutions;
Certain retirement entities.
Further, FFIs do not have to report amounts less than US $50,000 per individual. For specified U.S. persons disclosing their foreign financial assets, amounts less than US $50,000 for individuals residing in the U.S., and $200,000 for individuals residing overseas do not need to be reported on Form 8938. Form 8938 does not apply to domestic U.S. entities, only to individuals.
However, taxable income arising from these assets still needs to be reported on Form 1040, U.S. Individual Tax Return. Exemption from reporting does not mean exemption from tax. Further, individuals required to file Form 8938 may have to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) as well.
Do I have to report my income under FATCA?
If you are a specified U.S. person with foreign financial assets greater than US $50,000, you must report your income under FATCA using Form 8938. This is true regardless of whether those foreign financial assets will affect your tax liability for the year. However, if you do not have to file an income tax return for the tax year, you do not have to file Form 8938, even if the value of your specified foreign financial assets is more than the appropriate reporting threshold.
Because India signed the FATCA agreement with the U.S., Indian FFIs will report the financial accounts of U.S. specified persons to the MoF, and the MoF will report the information to the IRS. Indian FFIs no longer have to file individually with the IRS.
What are the penalties for non-compliance?
Failure to report foreign financial assets on Form 8938 may result in a penalty of $10,000, and a penalty up to $50,000 for continued failure after IRS notification. Further, underpayments of tax attributable to non-disclosed foreign financial assets are subject to an additional understatement penalty of 40 percent.
Because the cost of non-compliance is high both for filers of U.S. tax returns and for foreign financial institutions, it is recommended that individuals and institutions consult their tax professionals to determine whether filing is required in their circumstance. The IRS also provides an offshore voluntary disclosure program for individuals who have failed to disclose foreign assets in the past. The program allows taxpayers to come forward voluntarily and report their previously undisclosed foreign accounts and assets to avoid prosecution and limit their exposure to civil penalties.