The US has a unique tax system under which its citizens are taxed on their worldwide income, irrespective of whether they are US residents for tax purposes. The Foreign Account Tax Compliance Act (FATCA) is a part of the US Tax Code, which scouts for US taxpayers beyond the country’s shores.

FATCA requires reporting by Foreign Financial Institutions outside the US, and enforces reporting by withholding tax on certain payments to FFIs and other foreign entities. FFIs include banks, custodians, brokers, mutual funds, hedge funds, venture capital fund, and insurance companies. Under FATCA, FFIs should register and enter into agreements with the US Internal Revenue Service to identify and report US accounts.

‘US accounts’ refer to accounts held by individuals who are US residents and/ or citizens and by specified US persons; and by a non-US entity with one or more controlling persons who are specified US persons. Failure to comply will result in 30 per cent tax withholding from US-sourced payments with effect from January 1, 2014. Withhold-able payments include compensation, dividends, interest, pensions and annuities, rents and royalties, proceeds from sales or other dispositions derived from sources within the US. However, there will be no withholding on income arising from specified grandfathered obligations outstanding before January 1, 2014.

Registration Timelines

FATCA legislation has been in force since January 1, 2013. FFIs should register on the Internal Revenue Service’s registration portal from July 15, 2013. Registered institutions can agree to comply with FATCA obligations, as well as sign an FFI agreement, if not a reporting Model I FFI.

The IRS is expected to start issuing Global Intermediary Identification Numbers (GIIN) by October 15, 2013. October 25 is the expected date by which FFIs should register to appear in the December 2013 FFI list. The first list of participating FFIs is expected to be announced on December 2, 2013. Starting January 1, 2014, FFIs should implement new account on-boarding procedures to identify US accounts.

Inter-governmental Agreement

From the time draft FATCA regulations were first introduced in 2010 to the final enactment in January 2013, two approaches have emerged for their implementation. One is through direct agreement by the FFIs with the IRS; the second is the Inter-governmental Agreement (IGA) mode. The IGA approach is becoming increasingly acceptable to overcome the roadblocks of privacy laws in reporting FFI customer data. Another advantage is that there should be no withholding tax on the receipts by the FFIs, and none expected on the payments to recalcitrant account holders as well.

Under the Model I IGA, the FFI will report to the home country’s government, which, in turn, will share the data with the US. This is enabled by the “Exchange of Information” article under the respective country’s tax treaty with the US. The US has published two IGA Models — Model 1 (reciprocal and non-reciprocal basis), and Model 2. So far, it has signed Model 1 (reciprocal) IGAs with the UK, Denmark, Ireland, Mexico, Norway, and Spain; and Model 2 with Switzerland. It is exploring IGAs with other countries, including India.

FATCA and Indian FIs

Under FATCA, Indian Financial Institutions or FIs (including banks, non-banking financial companies, insurance companies, and mutual funds) should identify pre-existing US accounts (that is, accounts existing as on December 31, 2013). FATCA regulations prescribe various indices (such as US place of birth, residence address, mailing address or telephone number, and standing instructions to pay amounts to an address or account) to identify a US account. Most importantly, the FIs should identify US accounts for new customer accounts from January 1, 2014. They should first determine whether the account is an US account, and then perform due diligence for documentation. Reporting to the US Internal Revenue Service on accounts exceeding specified minimum amounts will begin after March 31, 2015. They should report identified US account holders who refuse to cooperate with documentation.

FATCA is a complex piece of foreign legislation — Indian FIs are struggling to understand the final regulations and their impact on the current “Know Your Customer” (KYC) procedures. The FIs are required to carry out impact assessment and gap analysis on their existing systems and processes. The resultant changes needed will involve substantial time and costs. Besides, Indian FIs are faced with several uncertainties.

If the Indian IGA does not come through before the end of 2013, are Indian FIs required to register with the US Internal Revenue Service? Will there be tax withholding in the absence of an IGA?

The US follows the calendar year for reporting, whereas India’s reporting year is April to March. Should the FIs make changes to their systems to comply with FATCA?

The IGAs signed so far have outlined a number of financial institutions and products in the respective jurisdictions that will be out of scope or have reduced obligations for FATCA reporting. Which Indian entities will be considered exempt FFIs ?

If the IGA is not signed in time and there is withholding of tax, will such tax be refunded? (If withholding occurs because an FFI is not compliant, it will generally not be refundable.)

FATCA and Indian Entities

FIs also have to identify and report accounts of passive non-US, non-financial entities that are controlled by US-specified persons.

So an FI should identify its entity accounts and obtain certifications on whether their status is active or passive, whether they are controlled by US-specified persons, and report entity accounts controlled by US-specified persons.

So, FIs would be reaching out to their US indicia and US-specified entity accounts to obtain certifications for the entity, as also information on the controlling persons, and so on.

The road ahead

FATCA is just the start of things to come. The draft model IGA includes a clause whereby countries are committed to working with the US, the Organisation for Economic Co-operation and Development, and the European Union on adapting the terms of the IGA and other agreements to a common model for automatic exchange of information, including the development of reporting and due diligence standards for financial institutions.

Bahroze Kamdin is Partner and Smita Parulkar is Senior Manager at Deloitte Haskins & Sells

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