FATCA Compliance: What does it mean for mutual funds in India?

To avoid costs of compliance, financial institutions in India may decide to filter the US client that they want to be on board. However, the actual impact be realised once RBI, SEBI and other regulators come out with guidelines to ensure compliance with FATCA in their respective domains

The Foreign Account Tax Compliance Act (FATCA), a US legislation meant to target tax non-compliance by US citizens with offshore accounts, has reached the Indian boundary. Regarded as one of the most controversial extra-territorial tax legislations, the Act is likely to impact various types of financial institutions in India such as deposit taking institutions, mutual funds, insurance companies and brokering firms. Regulators in India are bracing up to ensure that financial institutions in India adhere to the FATCA guidelines once it comes into force with effect from 1 July 2014.

Why it is that FATCA has suddenly become so important for India? The reason for growing significance of FATCA comes from the fact that India has entered into in-substance agreement with the US to implement FATCA guidelines. Under FATCA guidelines, there are two types of inter-governmental agreements (IGA), which countries are expected to enter into with the US to avoid non-compliance of FATCA. These are called as Model-1 and Model-2 of the inter-governmental agreements. India has consented to MODEL-1 of IGA.

So what does Model-1 agreement mean? Under Model-1, foreign financial institutions (FFIs) for the US perspective, say an insurance company or bank operating in case of India, would be required to report all FATCA-related information to Indian governmental agencies, which would then report these information to Internal Revenue Service (IRS). Some Model-1 IGAs have also provision for reciprocity, requiring the US to provide certain information about residents of the Model-1 country to the Model-1 country in exchange for the information that country provides to the US. Since India has entered into an agreement under Model-1, Indian financial institutions need not sign an FFI agreement, but they will need to register on the IRS’s FATCA Registration Portal or file form 8957.

So how does FATCA impact financial institutions in India, particularly mutual funds? While the details of the impact are yet to be known, it is very obvious that this act is going to throw various challenges with respect to compliance for mutual funds. Here, are a series of steps that mutual funds will require to take to ensure so that they are FATCA complied and avoid any withholding tax as per the act.

Step-1: Identify US persons who have invested in mutual funds in India:  The first step would be to identify persons from the US, who have invested in mutual funds in India. US person for tax purposes are generally considered as:

• A citizen of the US (including an individual born in the US but resident in another country, who has not renounced US citizenship);
• A lawful resident of the US (including a US green card holder);
• A person residing in the US.
• Somebody who has spent considerable period of time in US on a yearly basis.
• American corporations, estates and trusts may also be considered US persons

The need for identifying US person arises from the fact that money invested by these entities in India, need to be reported to IRS in the US.

Step-2: Identify what needs to be reported: Foreign financial institutions or FFIs need to report to the IRS under FATCA. While the threshold limit for reporting will be specified by the regulators in India based on FATCA regulation, mutual funds will need to understand the reporting requirements under FATCA, in terms of threshold limits. As per FATCA, US persons need to report to IRS in the following scenarios:

• If the total value is at or below $50,000 at the end of the tax year, there is no reporting requirement for the year, unless the total value was more than $75,000 at any time during the tax year.
• The threshold is higher for individuals who live outside the United States.
• Thresholds are different for married and single taxpayers.

The threshold of $50,000 may become applicable in case of mutual funds in India as well. This would require tracing all accounts, which have investments beyond this limit. There is a provision for third party reporting under FATCA for FFIs which says, “Foreign financial institutions may provide to the IRS, third-party information reporting aboutfinancial accounts, including the identity and certain financial information associated with the account, which they maintain offshore on behalf of US individual account holders”.

Step-3: Understand registration process, responsibilities and penalties:  Since India has signed Model-1 agreement, mutual funds in India will have to register with IRS and obtain Global Intermediary Identification Number (GIIN). The basic requirement under FATCA for mutual funds is to identify reportable accounts and provide details of these accounts to IRS.

FATCA imposes certain obligations on foreign financial institutions, which will become applicable for mutual funds in India as well. Under FATCA, FFIs that enter into an agreement with the IRS to report on their account holders may be required to withhold 30% on certain payments to foreign payees if such payees do not comply with FATCA.

Unless otherwise exempt, FFIs that do not both register and agree to report face a 30% withholding tax on certain US-source payments made to them. Since mutual funds do not fall under exempt category, these funds will to face issue of withholding tax and hence it becomes important to ensure compliance.

Basically, FATCA will result into higher compliance cost for mutual funds in India. There is a possibility of penalty as well if the compliance requirements are not met. Many mutual funds may weigh cost-benefit options arising from this new legislation as well. In order to avoid costs of compliance, financial institutions in India may decide to filter the client that they want to be on board. However, the actual impact be realized once Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) and other regulators come out with guidelines to ensure compliance with FATCA in their respective domains.