Offshore Tax Compliance for Investments in India

Foreign Nationals & Expats

Houston Tax Attorney

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FATCA India Compliance for Investments in India

For US residents with investments in India, compliance with FATCA and the US tax code can be burdensome. Indian clients often receive incorrect information from friends, family, and sometimes even their tax advisors. Since we receive a large number of Indian clients, we’ve created a short guide that may assist such individuals in properly reporting their foreign income and assets.

Worldwide Tax Reporting Requirements for U.S. Persons

U.S. Persons

The U.S. is one of the few countries in the world that taxes its residents on worldwide income and requires reporting of foreign assets. Immigrants from countries such as India may not understand or even know about these reporting requirements. In fact, many clients have come to us after having assumed that all U.S. income is reported in India and all Indian income is reported in India. While this may seem intuitive, it is not correct and can lead to major tax penalties if the IRS catches on. We’ll go over some of the penalties associated with unreported foreign income and assets later.

There are three classes of persons that are considered U.S. tax persons and are required to report worldwide income and assets above certain thresholds.

  1. U.S. Citizens
  2. Green Card holders
  3. Anyone who is present in the U.S. for at least 183 days in a given 1 to 3 year period. Read more about the substantial presence test and how it is calculated.

FinCEN 114 “FBAR”

If you fall into one of the above classes and have foreign financial accounts such as bank accounts, mutual funds, life insurance, and pensions, and the maximum total balance of all these accounts exceeds $10,000, you must file FinCEN Form 114, also known as FBAR. Read more about FBARs.

Form 8938 “FATCA”

If you are a U.S. person and the value of your specified foreign financial assets exceed tthe following thresholds,  you must file a Form 8938 with your tax return. Read more about Form 8938.

  • Unmarried taxpayers living in the U.S. and married taxpayers filing separate returns living in the U.S. – $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
  • Married taxpayers filing a joint return and living in the U.S. – $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.
  • Unmarried taxpayers living outside the U.S. –  $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.
  • Married taxpayers living outside the U.S. and married taxpayers filing separate returns living outside the U.S. – $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year

Form 8621 “PFICs”

If you own Indian stocks or mutual funds, you may have to report these investments on Form 8621. There is a special tax for such investments that are considered Passive Foreign Investment Companies or “PFIC”. Read more about PFICs.

Types of Indian Investments and Potential Reporting Requirements

Fixed Deposit Accounts

This is probably the most common type of unreported income in our streamlined cases involving Indian nationals. Those owning “fixed deposit” or savings accounts in India usually have an NRE or NRO account which is available for non-residents of India. Fixed deposit accounts are similar to CDs in the US.

Myth: Because the account holder will not receive the interest income until maturity, it is not reported on the US tax return.

Fact: Any interest accrued in such accounts, even if they are not yet distributed, are taxed in the US.

Public Provident Funds (PPF) and Employee Provident Funds (EPF)

A public provident fund (PPF) is a long-term investment option that is backed by the Government of India.

Myth: Because these are long-term investments that cannot be withdrawn until maturity (15 years), the income is not taxable in the US. In addition because it exempt from tax under 80C of the Indian tax code, that it is not taxable under the Internal Revenue Code.

Fact: The US does not recognize PPFs as tax-free investments.

Those with investments in PPFs are required to report all interest, dividends, and capital gains, even if they are “reinvestments”. It is unclear whether the accrued interest should be reported as it accrues or when it matures. Either way, the method should be consistent.

An Employee Provident Fund (EPF) is similar to a PPF, but it’s more like a 401(k) or IRA in the US. An EPF is a fund to which both a salaried employee the and employer may contribute a portion (12%) of the salary as a tax-deferred investment (tax-deferred in India). Since there is a maturity period before which the money can be withdrawn, it’s unclear whether the accrued interest should be reported as it accrues or when it matures. Either way, the method should be consistent.

Myth: If the account holder does not withdraw any money from an EPF, it is not taxable in the US.

Fact: The only types of employee pensions that can grow tax-free are those that are recognized under Section 401(k) of the Internal Revenue Code. A foreign employer sponsored deferred compensation plan is usually “non-qualified” and falls under the provisions of IRC 402(b). Non highly-compensated employees will be taxed when the benefits are distributed, but highly-compensated employees will be taxed on the growth. Employer contributions are taxable when made.

Life Insurance

Term life insurance plans are not reported on the US tax return or the FBAR. However, if the plan has cash value, such as a Unit Linked Insurance Plan (ULIP), there may be taxable income.

Myth: Life insurance is not taxable until the policy has been surrendered.

Fact: A ULIP is an investment portfolio. Any interest, “bonuses,” or dividends, including reinvestments are taxable. Additionally, you may have a PFIC filing requirement since this is a securities-based investment and have control over the investment choices.

Mutual Funds

Any interest, dividends, or capital gains from foreign mutual funds are taxable in the US. Additionally, they are likely also to be subject to the PFIC rules.

Demat Accounts

A demat account (short for dematerialized account) are shares and securities held electronically. These are paper stocks that have been dematerialized into electronic form. Additionally, they may be subject to PFIC reporting requirements.

Myth: Demats are not “real stocks” and do not need to be reported on the FBAR.

Fact: A demat account is considered a financial account and must be reported on the FBAR.

Penalties for Failing to Report Foreign Income and/or Assets

Maximum Penalties

Penalties for failing to report foreign income or any one of the foreign information reporting forms such as FinCEN 114, Form 8938, Form 8621, Form 5471, or Form 3520 can be enormous.

FormMaximum Penalty AmountStatutory Authority
FinCEN 114 (FBAR)$10,000 penalty for each non-willful violation (each year).
The greater of $100,000 or 50 percent of the account’s highest balance for willful violations.
31 U.S.C. sec. 5321
Form 8938$10,000 penalty for each violation (per year).

The maximum additional penalty for a continuing failure to file Form 8938 is $50,000.
IRC 6038D(d)
Form 35205 percent of the amount of such foreign gift (or bequest) for each month for which the failure continues after the due date of the reporting U.S. person’s income tax return (not to exceed 25% of such amount in the aggregate.IRC 6677(a)

These are maximum penalties per occurrence (i.e. per year). However, there are mitigating factors that the IRS will consider when assessing penalties.

Tax Treaty Relief

The following are some of the rules modified by the U.S. – India DTAA:

  • Dividends paid by Indian companies to U.S. residents will be taxed in the U.S. (no relief here) However, there is a reduced tax rate on that income in India.
  • Interest paid to U.S. residents will be taxed in the U.S. (no relief here) However, there is a reduced tax rate on that income in India.
  • Social security benefits and other public pensions are non-taxable in the U.S.
  • Government pensions (i.e., for government employees) are non-taxable in the U.S.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.