How new US tax law on foreign account will impact US investors in India

If you are a US resident with investments/assets in India, get ready for tighter scrutiny by the authorities here, thanks to the US government's renewed focus on tax avoidance by its residents.

The US has enacted a law, the Foreign Account Tax Compliance Act (FATCA), which will soon start applying here. Under the law, all financial institutions (brokerages, mutual funds, insurance companies, banks and hedge funds) in India are required to furnish information about US residents' financial accounts or investments to the US tax department - the Internal Revenue Service (IRS).

US taxpayers include US citizens, US residents (green card holders) and non-residents who own foreign financial accounts or other offshore assets.

In order to get the law implemented, the US government is signing Inter-Government Agreements (IGAs) with other countries. It is likely to sign one with India before December. After that, financial institutions in India will have to report the tax residency of their clients (both existing and new) to the Indian authorities, who in turn will forward the information to the US government.

THE PURPOSE

The aim of the new law is to curb tax evasion. A financial institution is required to get itself registered with the IRS and get a Global Intermediary Identification Number (GIIN). Indian financial institutions will have time till December 31 to get GIIN. They may be required to withhold tax at 30% from taxpayers who do not comply with the FATCA rules.

"The mandatory reporting will be a huge operational inconvenience. We have over 900,000 clients. We will have to go back to them and seek updated KYC (know-your-customer) details. This will take some doing," says Trivikram Kamath, CFO and head, operations and IT, Kotak Securities. He says more countries will follow suit. "This is just the tip of the iceberg," he says.

HOW DO INVESTORS GET IMPACTED?

Investors will have to give correct information about their tax residency and financial assets. This information will then be reported by financial institutions to the country's authorities.

While all new investors will have to comply with the rules, existing investors with less than $50,000 assets have been exempted.

In case of failure to comply with the new rules, the financial institution may withhold 30% tax on assets held by the investor with it. In some cases, fresh investment requests may be rejected or investors may be made to redeem their investments.

To lower the 'reporting' burden, a few financial institutions such as mutual funds have stopped accepting fresh investment from US residents.

Large fund houses like HDFC Mutual Fund and ICICI Prudential Mutual Fund bar US and Canada-based NRIs from investing in their schemes. For an existing investor who becomes a US or Canada resident, all facilities such as switch of schemes, dividend reinvestment, systematic investment plans, systematic transfers, etc, will be stopped and the investor will be made to sell out. However, such investors can invest in offshore funds launched by Indian asset management companies, or AMCs, in the US. Offshore funds usually replicate a successful fund back home.

"US norms require a fund scheme and asset manager to be registered with the SEC under their 1940 Act and conform to their provisions to be able to accept investments from US residents. Thus, we clearly mention in our communication that we cannot accept investments from US residents. However, US residents interested in taking part in the India story can do by investing in India funds or exchange-traded funds domiciled in the US. There are a handful of them in existence." says Karun Marwah, head of International Business, ICICI Prudential Mutual Fund.

But not all mutual funds have stopped taking investments from US-based NRIs. Many are ready to comply with FATCA.

Will other financial institutions follow suit and stop taking investments from US residents? So far, except for mutual funds, no other financial institutions have given any such indication.

"It (FATCA) will deter institutions from accepting investments (especially) from smaller investors," says Rakesh Nangia, managing partner, Nangia & Co.