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Common Issues for US-India Tax Reporting
In 2015, India and the US signed an agreement to implement the Foreign Account Tax Compliance Act (FATCA) that will facilitate exchange of information between the two countries starting on October 1, 2015. Under the agreement, Indian financial institutions would have to reveal information about US taxpayers to the revenue department which would be passed on to the US tax authorities.
In 2016, India and the US agreed to enhance collaboration on tackling offshore tax evasion and increase cooperation in sharing of cross-border tax information between the US Treasury and the Indian Ministry of Finance.
Know your customer (KYC) = Know your risks
The Government of India continues to crackdown on self-certifications and know your customer (KYC) compliance for financial accountholders.
The Indian government said that the account holders of any Indian financial institutions need to provide self-certification of compliance under US Foreign Account Tax Compliance Act (FATCA). Failure to provide self-certification of compliance would result in the noncompliant accounts being blocked and inaccessible for any transactions. All Indian investors (including NRIs), who hold accounts in any Indian financial institutions such as mutual funds or fixed deposits, need to file a FATCA self-certification form.
The FATCA certification form WILL LEAD to disclosure to the US government. So know your risks. Account holders MUST be certain they are in full compliance with all United States reporting requirements to avoid future tax and legal problems. The IRS has established several amnesty programs, under which a previously non-compliant individual can become compliant and avoid potentially very high penalties or criminal prosecution. However these amnesty programs generally require the taxpayer to come forth before being contacted by the IRS. Accountholders should speak with a competent US tax lawyer before completing any self-certifications or know your customer (KYC) documents for noncompliant accounts.
The US-Indian Treaty:
While there is a US-Indian tax treaty that claims to offer benefits, the issue is that the “Savings Clause” of the treaty negates the double-taxation prohibition. Meaning, anything earned in India is subject to US taxation. However, the foreign income exclusion applies if you are domiciled in India, and you may be entitled to a foreign tax credit for any taxes paid in India.
The NRE/NRO trap:
Indians not living in India can only have NRE/NRO accounts. The benefit is that these accounts are tax-free in India. If an Indian is also a US person, a NRE/NRO is taxable. This trap has caused many Indians to fail to disclose their worldwide income and many have had to enter into some sort of offshore disclosure program.
Are you a US person living in India?
In India, resident taxpayers are taxed on their worldwide income. However, non-resident taxpayers are taxed only on income received in India or on income arising in India.
The US taxes its persons on a worldwide basis. So what you earn in India, even if it is taxed by the Indian taxing authority, is subject to additional taxes by the IRS. This is true even if you have a “tax-free” account in India. However, you are entitled to a credit for taxes paid. In the alternative, there is a foreign income exclusion which will exempt a portion of your income from income taxes.
Are you an Indian person living in the United States? (Visa/Substantial Presence Test):
If you are a Green Card holder you are subject to universal taxing jurisdiction on all your income, anywhere in the world. If you are a visa holder the rules are a bit more complicated about when universal taxing jurisdiction is triggered.
The FBAR is a reporting form for those who hold $10,000 or more (in the aggregate) in a foreign financial account. You must also include things like life insurance policies, mutual funds, accounts you only have signatory authority on, and more. Learn more about FBARs here.
FATCA Reporting & Form 8938:
Certain U.S. taxpayers holding specified foreign financial assets with an aggregate value exceeding $50,000 need to report information about those assets on IRS Form 8938, which must be attached to the taxpayer’s annual income tax return. Higher asset thresholds apply to U.S. taxpayers who file a joint tax return or who reside abroad.
More on the Foreign Earned Income Exclusion:
Citizens and residents living and working outside the U.S. may be entitled to a foreign earned income exclusion that reduces taxable income. In addition, you may exclude housing expenses, but with limits. There are limits and special rules about who qualifies for the exclusion, and we can help you understand if you qualify.
Based on our experience, we find that there are many complicated aspects of treatment of different types of accounts in India. For example:
- Fixed deposits (FD) roll over into new FDs with new account numbers, and hence treated as new brand new accounts for reporting purposes.
- Fixed deposits with a term over one year must be given OID treatment; interest is taxed when accrued, not earned.
- Indian life insurance is typically non-qualified and must receive 7702G computations.
- HSBC India is on the foreign facilitators hotlist.
- Indian Mutual Funds require PFIC computations using Form 8621.
- We treat EPFs as employee trusts. This means they need special treatment under IRC 402(b) and distributions are effectively taxed under code section 72.
- PPFs are taxed yearly on the interest amounts.
- Knowing the difference between NRE and NRO accounts is of the utmost importance.
- If you have a pension fund from a former employer, this needs special treatment.
- Indian DEMAT Accounts involved complicated accounting, along with FBAR reporting.