EY Tax Alert. Executive summary

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1 21 July 2015 EY Tax Alert India signs the Inter-Governmental Agreement with the United States of America to implement Foreign Account Tax Compliance Act to promote transparency on tax matters Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your Ernst & Young advisor Foreign Account Tax Compliance Act (FATCA) was enacted in 2010 by the Government of the United States of America (GO US) with a view to combat tax evasion by U.S. citizens and residents through the use of offshore accounts. FATCA requires financial institutions (i.e. Banking and Insurance companies, Custodial Institutions, Asset Management Companies, etc) across the globe to share information about the financial accounts (i.e. depository account in case of Banks, insurance/ annuity contract in case of insurance companies, custodial account in case of custodial institutions, etc) held by U.S. citizens and residents, with the Internal Revenue Service (IRS) of the United States of America (USA). To enable financial institutions in India to comply with FATCA, the Government of India (GOI) signed an Inter-Governmental Agreement with the GO US on 9 July 2015 (India IGA). In addition to this agreement, a memorandum of understanding is also entered into between the GOI and the GO US with respect to certain terms used in the India IGA for compliance with FATCA. The India IGA agreement shall enter into force on the date of India s written notification to the USA that India has completed its necessary internal procedures for enforcing the India IGA. India proposes to complete the internal procedures at the earliest with a goal of having the India IGA enter into force on 30 September This alert summarises the terms of the India IGA entered into between GOI and the GO US.

2 Background FATCA was enacted in 2010 by the GO US with a view to combat tax evasion by U.S. citizens and residents through the use of offshore accounts. FATCA requires financial institutions across the globe to share information about the financial accounts held by U.S. citizens and residents, with the IRS of the USA. For this purpose, FATCA requires financial institutions to register with the IRS and obtain a Global Intermediary Identification Number (GIIN) and undertake due diligence of its records (typically the documents obtained from the customers at the time of opening the accounts) to identify whether the financial account is held by a U.S. citizen/ resident, or not. Government of the country of which such financial institution is a resident and the GO US. The FFI Agreement typically provides: 1. the scope of FATCA i.e. the type of financial institutions who are required to comply with FATCA and the type of financial accounts in respect of, which such financial institutions are required to share the information; 2. the due diligence procedures; 3. nature/ type of information to be shared; and 4. form, manner and periodicity of sharing the required information. To enable financial institutions in India to comply with FATCA, the GOI signed the India IGA for the implementation of FATCA on 9 July Failure to comply with any provision of FATCA by the financial institution would result in withholding of tax, at the rate of 30% from U.S. Sourced Withholdable Payments 2 to be made to such financial institution. The India IGA is reciprocal in nature i.e. GO US will also share the information as agreed with the GOI about the accounts held by the residents of India with the financial institutions in the USA. Ways to comply with FATCA There are 2 ways to comply with FATCA: 1. Financial institutions across the globe can enter into a Foreign Financial Institution Agreement (FFI Agreement) with the IRS; or 2. Financial Institutions can comply with an Inter-Governmental Agreement entered into between the The India IGA shall enter into force on the date of India s written notification to the USA that India has completed its necessary internal procedures for enforcing the India IGA. India proposes to complete the internal procedures at the earliest with a goal of having India IGA, enter into force by 30 September The India IGA consists of three sections: 2 any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the United States. Base Agreement comprises of definitions, types of information to be exchanged with respect to the Reportable Accounts 3, time and 3 Reportable Account means the account in respect of which information needs to be shared/ reported.

3 manner of exchange of information, term of the agreement etc. Annexure I prescribes due diligence procedures to be followed by the financial institutions for identifying whether the financial account is held by a U.S. citizen/ resident, or not. Annexure II: prescribes type of financial institutions 4 that are treated as Exempt Beneficial Owners (inter alia includes Government entities, International Organisations, Central Bank 5, Gratuity Fund, Provident Fund and Employees State Insurance Fund etc) and Deemed Compliant Financial Institutions (inter alia includes financial institutions with a local client base, Local Bank, Investment Advisors/ Investment Managers /Stock Brokers/ Trading Members of Recognized Stock Exchanges, etc). It also prescribes the type of financial accounts which not covered within the purview of FATCA. shall not be subject to withholding tax from U.S. Sourced Withholdable Payments where, interalia, the following conditions are fulfilled: The financial institutions in India identifies Reportable Accounts and reports annually to the Indian competent authority 6, the information required to be reported. Complies with the applicable registration requirements on the IRS FATCA website. This alert highlights the key features of this India IGA. Applicability and scope All the financial institutions 7 in India are required to comply with the provisions of the India IGA. The financial institutions shall include: Custodial Institution 8 ; Depository Institution 9 ; Investment entity 10 A financial institution in India shall be treated as complying with FATCA and 4 The financial institutions specified above shall be treated as exempt beneficial owners or deemed compliant financial institutions subject to fulfillment of certain conditions mentioned in Annexure II to the India IGA. The term exempt beneficial owners and deemed compliant financial institutions is not defined in India IGA. Thus, it is difficult to understand the rationale behind classification of the financial institutions mentioned above into these categories and compliance requirement for these categories of financial institutions. 5 For the purpose of India IGA, Central Bank shall mean the Reserve Bank of India. 6 As per the India IGA, Finance Ministry is considered as the Indian Competent Authority. 7 The branches of the financial institutions in India which are located outside India shall be governed by the law prevailing in the respective jurisdiction. Further, the branches of the financial institutions not resident in India which are located in India shall be governed by the India IGA. 8 an entity that holds as a substantial part of its business, financial assets for the account of others. 9 any entity that accepts deposit in the ordinary course of banking or similar business. 10 any entity that conducts as a business (or is managed by an entity that conducts as a business) one or more of the following activities or operations for or on behalf of the customer:

4 Specified Insurance Company 11 The financial accounts in respect of which the financial institutions are required to share the information are as under: Custodial account 12 Depository account 13 Cash Value Insurance Contract 14 / Annuity contract 15 a) trading in money market instruments (cheques, bills, certificates of deposit, derivatives, etc.); foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading; A financial account shall also include equity or a debt interest in an entity in certain situations. The accounts that are excluded from the definition of financial accounts are specified in Annexure II to the India IGA and inter alia includes Certain Savings Account (i.e. Retirement and Pension Account), Non-Retirement Savings Accounts, Certain Term Life Insurance Contracts, Account Held by an Estate, Escrow Accounts etc 16. Due diligence procedures b) individual and collective portfolio management; or c) otherwise investing, administering, or managing funds or money on behalf of other persons. 11 any entity that is an insurance company (or the holding company of an insurance company) that issues or is obligated to make payment with respect to a Cash Value Insurance Contract or an Annuity Contract. Due diligence procedures are prescribed in Annexure I to the India IGA. For the purpose of due diligence, financial accounts maintained by the financial institutions are bifurcated into individual accounts and entity accounts i.e. the accounts held by entities. 12 means an account (other than an Insurance Contract or Annuity Contract) for the benefit of another person that holds any financial instrument or contract held for investment (including, but not limited to, a share, stock, bond, debenture, derivatives etc.). 13 includes any commercial, checking, savings, time, or thrift account, or an account that is evidenced by a certificate of deposit, thrift certificate, investment certificate, certificate of indebtedness, or other similar instrument maintained by a financial institution in the ordinary course of a banking or similar business. A Depository Account also includes an amount held by an insurance company pursuant to a guaranteed investment contract or similar agreement to pay or credit interest thereon. 14 means an Insurance Contract (other than an indemnity reinsurance contract between two insurance companies) that has a Cash Value (i.e. amount which the policyholder is entitled to receive upon surrender/termination or as borrowings against the policy) greater than $50,000. The term Insurance Contract means a contract (other than an Annuity Contract) under which the issuer agrees to pay an amount upon the occurrence of a specified contingency involving mortality, morbidity, accident, liability, or property risk. Individual accounts are further bifurcated into pre-existing individual accounts i.e. accounts existing on 30 June 2014 and new individual accounts i.e. accounts opened on or after 1 July Similarly, entity accounts are bifurcated into pre-existing entity accounts and new entity accounts. Single premium life insurance contracts that do not permit an amount to be paid on surrender or termination of the contract and that do not allow amounts to be borrowed under or with regard to the contract, do not constitute a cash value insurance contract. 15 Contract under which the issuer agrees to make payments for a period of time determined in whole or in part by reference to the life expectancy of one or more individuals. 16 Exclusion is subject to the fulfillment of conditions mentioned in Annexure II to the India IGA.

5 Separate due diligence procedures are prescribed for individual accounts and entity accounts. As per the India IGA the following accounts are not required to be reviewed, identified and reported: but only to the extent the financial institutions computerized system link the financial account by reference to the client number or tax identification number and allow account balance or a value to be aggregated. A pre-existing individual account having account balance or a value of less than $ 50,000 ($ 250,000 in case of cash value insurance contracts or an Annuity contract) as of 30 June New individual account i.e. depository account and cash value insurance contract unless the account balance or value exceeds $ 50,000 at the end of the calender year or other appropriate reporting period. A pre-existing entity account with an account balance or a value that does not exceed $ 250,000 as of 30 June 2014 until the account balance exceeds $ 1,000,000. New entity account being credit card account or a revolving credit facility provided the financial institution maintaining such account implements policies and procedures to prevent an account balance owed to the account holder that exceeds $ 50,000. each joint holder shall be attributed the entire balance or value of the jointly held account by the financial institutions. financial institutions must convert the threshold amounts mentioned above using a published spot rate determined as of last day of the calender year preceeding the year in which financial institution is determining the balance or value. In case of financial accounts held by individuals: financial institutions are required to electronically search the data maintained by it to identify whether the account is held by a U.S. citizen or resident for tax purposes. in certain situations, financial institutions are also required to undertake paper record search and relationship manager enquiry. In case of financial account held by entities: For the purpose of determining the above limits: financial institutions are required to aggregate all financial accounts maintained by such financial institutions or by a related entity 17 financial institutions are required to identify whether the entity holding the financial account is incorporated or organised in the USA or has a U.S. address. where the entity is not incorporated or organised in the USA or does not 17 An entity is a Related Entity of another entity if either entity controls the other entity or the two entities are under common control. For this purpose control includes direct or indirect ownership of more than 50 percent of the vote or value in an entity.

6 have a U.S. address then financial institutions are required to identify whether the financial account is held by any financial institution or not and if the financial account is held by a financial institution then identify whether such financial institution is complying with the provisions of FATCA. where the financial account is held by an entity which is not a financial institution, then for identifying whether the financial account is held by a U.S. citizen or resident for tax purposes or not, financial institutions in India must undertake due diligence of the beneficial owners of the entity holding the financial account. balance, gross income paid into the account etc. The financial institutions are required to share the information with the Ministry of Finance who in turn will share the information with IRS pursuant to Article 28 of the convention between the GOI and GO US for the Avoidance of Double Taxation and Prevention of Fiscal Evasion, which authorises exchange of information for tax purposes including on an automatic basis. As per India IGA, Ministry of Finance is required to share the information with IRS within 9 months from the end of the calender year to which the information relates. Where the financial accounts are identified as held by the U.S. citizens or U.S. residents for tax purposes pursuant to due diligence procedures so prescribed then such accounts should be treated as Reportable Accounts 18 by the financial institutions. Since, India proposes to complete the internal procedures at the earliest with a goal of having India IGA, enter into force by 30 September 2015, first reporting/ sharing information by the financial institutions in India is likely to happen by 30 September Where the financial accounts are identified as held by financial institutions that are not complying with FATCA pursuant to due diligence procedures then such accounts should not be treated as Reportable accounts. However, the form, manner and the timelines by which, the financial institutions will be required to share the information with Ministry of Finance is yet to be specified. However, information in respect of such accounts must be shared/ reported by the financial institutions in India. Sharing of information As per the India IGA, the financial institutions are typically required to share information with respect to reportable accounts like name, address, taxpayer identification number, account 18 The account in respect of which information needs to be shared/ reported

7 Comments FATCA is rapidly becoming the global standard in the effort to curtail offshore tax evasion. Till date, more than 110 jurisdictions have signed the Inter-Governmental Agreements with the GO US. Signing of the India IGA is an important milestone in India s fight against the menace of Black money as it would enable the Indian tax authorities to receive financial account information of Indians from the USA on an automatic basis. It is a re-affirmation of the shared commitment of India and USA towards tax transparency and the fight against tax evasion and avoidance. To comply with FATCA, the financial institutions in India will have to amend their Know Your Client Procedures and would be required to update their IT infrastructure in a manner that would capture the information that needs to be shared/ reported.

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