The tax world is changing at a rapid pace. Tax planning is being closely scrutinized and monitored, and tax evasion is not tolerated. The use of offshore jurisdictions to minimize tax liability is being frowned upon and the regular exchange of information between jurisdictions is becoming the “new normal.”
The US, in 2010, enacted The Foreign Accounts Tax Compliance Act (FATCA), which became effective 1 July 2014. FATCA requires foreign financial institutions (FFIs) to report details relating to customers with US indicia to the Internal Revenue Service (IRS) or suffer a 30% withholding tax on certain US-sourced income. In order to operationalize FATCA and to overcome data-sharing challenges, the US Government has entered into Inter Governmental Agreements (IGAs) with several countries.
These IGAs either require Financial Institutions (FIs) to report details of the customers to a local designated tax authority (Model 1 IGAs), or the Government of the foreign country modifies its data protection laws to permit sharing of information by the FIs with the IRS directly (Model 2).
Taking a cue from the Model 1 IGA, the Organisation for Economic Cooperation and Development has also introduced a Common Reporting Standard (CRS), whereby Automatic Exchange of Information (AEOI) can happen between countries who agree to do so. Countries are encouraged to sign a Multilateral Agreement for AEOI.
India signed a Model 1 IGA with the US to implement FATCA on 9 July 2015, and has also signed the Multilateral AEOI on 3 June 2015. To facilitate reporting, India amended section 285BA of the Income-tax Act, 1961 (the Act) and notified Rule 114F to 114H in the Income-tax Rules (Rules). FIs in India are, therefore, required to put systems in place to be able to report data relating to foreign accounts to the Income Tax Department. The compliance requirements are complex and the reporting deadlines stringent.
Many FIs in India have already initiated the process of preparing themselves to comply with the new reporting requirements of the Indian tax authorities. The process is, however, arduous. It requires conducting due diligence of pre-existing accounts, obtaining self-declarations from new account holders, and verifying prima facie whether these are correct. Complex rules exist for identifying “in scope” FIs and “in scope” accounts, which adds to the difficulty as incorrect reporting can lead to imposition of a penalty, albeit small.
For customers of FIs as well, particularly non-individual (entity customers), it is worthwhile to examine if they are indeed “in scope” for reporting by the FIs with which they have accounts. Also, for large groups, it may be worthwhile to examine if certain holding companies and other entities earning only dividend/interest income may possibly qualify as FFIs themselves, and may have registration and reporting requirements that other FFIs do not have at present. Currently, non-compliance with reporting attracts a penalty of a minimum of INR100 per day.
To sum up, tax transparency and automatic information exchange are no longer concepts but are a part of the income tax law in India. Taxpayers in both the financial services and non-financial services sectors should critically evaluate their obligations and initiate actions to be able to comply by the prescribed deadlines. Time is of the essence, and the sooner this is initiated, the better.