US NRIs not welcome in Indian financial business

American NRIs who invest in India are up in arms that since April this year a large number of Indian mutual funds have stopped accepting investments from them. Some mutual funds' websites explicitly say so, while others have opted for quietly discouraging any such investors that turn up. And this sudden unwelcome attitude towards a formerly favoured class of investors is not limited to fresh mutual fund investments.

Some mutual funds are said to be preparing to weed out existing NRI investors, and something similar is going on with stock brokerages, banks and even some real estate developers. Predictably, many NRIs are protesting through various channels, both formal and informal, to the financial institutions which are suddenly treating them as outcasts as well as to the government. Unfortunately, even though the situation may improve, it is unlikely to go back to the way it used to be in the good old days. Regardless of the fervour they displayed at Madison Square Gardens (MSG), the days when US-based NRIs' investments were welcome everywhere is over for good.

Foreign Account Tax Compliance Act (FATCA)

The reason it won't change is that this issue is much broader than just NRIs or India. From April this year onwards, under a new US law, it has become extremely onerous for any financial institution around the world to deal with 'US persons', which includes US citizens, green card holders and some other types of people and entities. Broadly, the Foreign Account Tax Compliance Act (FATCA) makes it compulsory for all Financial Institutions in the world to report to the US Government comprehensive details of all transactions involving these 'US persons'. The obvious question is so what? What authority does the Unites States Government have to force businesses in other countries to do its bidding? But if you think about it, the answer is also obvious. Legally, the US Government has no actual authority.

However, what it does have is a big (financial) stick with which it is willing to beat up anyone in the world who doesn't do what it says. If a financial company doesn't collect and report this data to the US government, and it has any assets in the United States, then the US Government will confiscate 30% of those assets as a withholding tax. This also applies to any connected business — what we would call a group company. Of course a confiscation of 30% of assets would utterly destroy any financial business.

From what we learned, the problem is that complexity and cost of compliance is considerable, and the punishment for making a mistake is huge. Therefore, what FATCA boils down to is that if you have any intention of ever having any financial dealings in the United States, then you need to work as an unpaid tax collector for Uncle Sam, chasing down its citizens around the world. Take it or leave it. As said earlier, FATCA is far more than an NRI or India issue, but it does have a large impact on India.

Citizenship-based taxation rather than residency-based taxation

The root cause is that the US is apparently one of the only two countries in the world that has citizenship-based taxation rather than residency-based taxation. FATCA has had a huge impact on the desirability of having Americans as customers by financial businesses around the world and NRIs in India are no exception. The curious thing is that according to the official database that one can download from the US Internal Revenue Service's (IRS) website, more than four hundred Indian entities have signed an agreement of compliance with the IRS. This even includes some real estate developers.

The solution to the problem lies in Washington DC.

However, anecdotal reports suggest that many, even some of the ones who have signed up, are turning down business from US citizens. It looks likely that many financial businesses will sign the compliance agreements with the IRS, but may still avoid US citizens in order to avoid the cost, complexity and risk of reporting. At best, they'll limit themselves to dealing with a handful of lucrative accounts. That'll be a problem for a huge number of NRIs. Unfortunately, the solution to the problem lies not in New Delhi or Mumbai, but in Washington DC.