What is Fatca and how it’s used in Banks

All NRIs must adhere to global tax compliance systems for their offshore accounts. One of the most important sets of rules is outlined within the Foreign Account Tax Compliance Act or FATCA for NRIs living in the USA. 

Any NRI living in the USA and investing in Indian assets will have to adhere to the Foreign Account Tax Compliance Act (FATCA) laws. These legislations require financial institutions to declare details of accounts held by US taxpayers. FATCA also requires a self-declaration from NRIs living in the USA while making investments in India. 

Following the signing of the IGA, on 7 August 2015, the Indian Government enacted rules relating to FATCA reporting in India. A brief overview of the due diligence requirements and the rules that need to be maintained and reported by financial institutions is: 

  • Rule 114F – Definitions of the various terms referred to in the rules; 
  • Rule 114G – Information to be maintained and reported; and 
  • Rule 114H – Due diligence requirement. 

These rules have been divided into three specific segments which deal with various aspects of the FATCA reporting regime 

What is FATCA? 

FATCA is a tax information reporting regime, that requires Financial Institutions (FIs) to identify their U.S. accounts through enhanced due diligence reviews and report them periodically to the U.S. Internal Revenue Service (IRS) or in case of an Inter-Governmental agreement(IGA), to appropriate government authority. 

FATCA as a law thus, requires U.S. citizens living at home or abroad to file annual reports on any foreign account holdings they have. 

With the main goal of stopping tax evasion, FATCA was passed in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, which is designed to promote transparency in the global financial services sector. 

What is the core objective of FATCA? 

The objective of FATCA is to detect, deter, and discourage offshore tax evasion by U.S. citizens or residents by requesting information about U.S. persons to increase transparency for the U.S. 

FATCA’s provisions are designed with incentives for FFIs and USWAs to provide information to the IRS on financial accounts held by U.S. persons: 

  • Directly investing outside the U.S.; or 
  • Indirectly investing through a non-U.S. entity 

Foreign institutions outside of U.S. jurisdiction will have a strong incentive to comply in order to avoid

the 30% withholding tax on any withholdable payment received from sources within the U.S. levied on non-compliant individuals and entities. 

What is CRS? 

Common Reporting Standard (CRS) is a global-level uniform standard for the automatic exchange of financial account information. CRS is an initiative of G-20 countries and the Organisation for Economic Co-operation and Development (OECD) and is similar to FATCA. Under this standard, jurisdictions would obtain financial information from their financial institutions and exchange that information with other jurisdictions on an automatic annual basis. 

What is an IGA? 

An Intergovernmental Agreement (IGA) is a bilateral agreement between a country’s government and the U.S. government that facilitates compliance with FATCA. The model agreements enable FFIs in the designated jurisdictions to comply with FATCA, especially where privacy laws exist. There are currently two types of IGAs, Model I and Model II

A Model I agreement allows FFIs within the country to report to the local country authority, which will then provide the information to the IRS. Each country’s tax authority has a separate Model I Agreement with the IRS, which includes country-specific provisions in addition to simplified due diligence and withholding requirements. Under a Model II agreement, the FFI would directly report information to the IRS. 

FATCA India 

  • U.S. persons are required to report their global assets to the U.S. government when the threshold requirements for reporting are met. When a person is a citizen of India, but is also a U.S. Citizen, Legal Permanent Resident, or otherwise meets the substantial presence test, they are considered a U.S. person for tax purposes. 
  • As a U.S. person, the taxpayer must report their foreign assets, accounts, investments, and income to the IRS and FinCEN on a myriad of different international information reporting forms, such as FBAR and FATCA Form 8938. 

FATCA and other international tax penalties can be reduced or avoided through offshore tax amnesty programs. 

FATCA Reporting – India 

  • Many years ago, India and the U.S. entered into a FATCA Agreement (IGA) which requires Foreign Financial Institutions (FFI) in India to report U.S. account holder information to the IRS, and vice versa. 
  • Indian Banks such as ICICI, SBI, HDFC, and Axis routinely issue FATCA letters to customers.
  • These letters require the asset or account holder to disclose their U.S. citizenship or residence status, which is then forwarded to the U.S. government.
  • The IRS has taken an aggressive approach to foreign accounts compliance. Non-compliance with offshore accounts and income reporting may result in significant offshore fines and penalties.
  • If you are a U.S. person (living in the U.S. or abroad) and have accounts in India, the IRS may require you to report the maximum balances of each account on an annual basis. 

The Significance of FATCA in India – 

  • Combating Tax Evasion 

One of FATCA’s primary objectives is to combat tax evasion. Historically, Indian residents have used offshore accounts to hide income and assets, depriving the Indian government of tax revenue. 

FATCA’s reporting requirements help Indian authorities identify such accounts. 

  • Promoting Tax Transparency 

FATCA promotes transparency by facilitating the exchange of financial information between countries. This allows Indian tax authorities to verify that residents with foreign accounts are accurately reporting their income and assets. 

  • Strengthening India’s Financial Ecosystem 

Compliance with FATCA strengthens India’s position in the global financial ecosystem. It demonstrates India’s commitment to international tax regulations and fosters confidence among foreign investors. 

What is the purpose of FATCA/CRS? 

  • FATCA aims to prevent U.S. persons from using banks and other financial institutions outside the U.S. to park their wealth outside the U.S. and consequently avoid U.S. taxation on income generated from such wealth. 
  • FATCA-CRS obliges financial institutions to report information about U.S. persons having accounts with them. 
  • Similar to FATCA, the purpose of CRS is to aid the automatic exchange of information between bilateral treaty partner countries about account holders/investors maintaining accounts in foreign jurisdictions so as to avoid tax evasion on the funds parked in such countries. 

Difference between FATCA and CRS 

Buoyed by the success of FATCA, the Organisation of Economic Cooperation and Development (OECD) introduced the CRS or Common Standard on Reporting and Due Diligence for Financial Account Information. The CRS was based on similar regulations as the FATCA, but there are notable differences between the two. 

While both legislations were introduced to combat tax evasion, CRS has a more considerable breadth of design. It covers 90 countries except the US. Reporting of all financial accounts is mandatory under the CRS, while it is not compulsory for FATCA. FATCA concerns only people living in the USA and has a limit that exempts US taxpayers with an aggregate value of foreign financial assets less than $50,000. CRS does not have any such exemptions.

What Are The Implications For Non-Compliance? 

The implications of non-compliance with the FATCA are severe for both foreign financial institutions and individuals. 

For foreign financial institutions, failing to enter into a legally binding agreement with the IRS to disclose information about their U.S. clients may result in a 30% withholding tax rate on all related payments received. 

This means that 30% of all deposits, dividends, or interest payments may be withheld from investors. In addition, the foreign financial institution may be subject to penalties for failing to report correctly. 

What are the compliance requirements of FATCA? 

To comply with the final FATCA regulations released on January 17, 2013, all financial institutions must identify and classify their account holders and report on all accounts (products and services) directly or indirectly owned by U.S. taxpayers, foreign financial institutions (FFIs) and non-financial foreign entities as required. 

FATCA compliance requires FFIs, including foreign subsidiaries of U.S.-based organizations, take steps to: Enter into an FFI agreement with the IRS that states its intent to comply with FATCA Conduct due diligence for new and existing accounts to classify account holders or investors as either U.S. or non-U.S. 

  • Withhold 30% in U.S. taxes when individuals fail to provide the appropriate documentation or when doing business with non-compliant entities 
  • Report account information directly to the IRS or indirectly through their national government which have signed Intergovernmental Agreements (IGA

To whom does FATCA apply ? 

According to FATCA, everyone living in the USA is subject to this tax law. These include: US permanent residents or green cardholders 

  • US citizens or NRIs who have migrated to the US and are now its naturalized citizens NRIs and Persons of Indian Origin (PIO) working in the US via B1/B2, H1-B, E-2, or L1/L2 visa 

US-India agreement – FATCA implementation 

FATCA ensures tax compliance and transformation at a global level. It presents foreign financial institutions with a chance to improve and streamline their tax reporting process. It also gives them visibility in the foreign country and gains the trust of investors. 

To accommodate FATCA, the government had inserted Rules 114F to 114H and Form 61B in the Income Tax Act in 2014. The Indian Government also signed the Inter-Governmental Agreement (IGA) with the United States of America in the year 2015 for the implementation of FATCA

According to the agreement, Indian tax officials are required to obtain specific account information from US investors. The goal was to ensure tax compliance by the US citizens while increasing transparency for

the Internal Revenue Service (IRS). This gave a legal basis for the reporting financial institutions to maintain and report personal and income details.