India NRI & PPF Closure – IRS & FATCA Compliance for U.S. Transfers
For many individuals who are either Indian citizens or residents of India, opening up a PPF (Public Provident Fund) is standard practice.
It is a great investment because it grows tax-free until the time of distribution. Unfortunately, once a person becomes a U.S. person, the PPF becomes a lot more complicated.
*We have a separate article summarizing FATCA and India specifically.
U.S. Taxation of a PPF
The reason that the PPF becomes so complex is because technically, since a PPF is generating interest income and dividends (even though it is not being distributed), it is taxable in the United States.
This is a major downfall for the PPF for individuals who are U.S. persons because instead of growing tax-free, it is now taxable in the United States.
Moreover, if the person is going to return to India in the future, he or she may have unnecessarily paid U.S. tax on earnings, and may not receive a tax credit down the line in India.
There are two major issues involving the PPF (noting that the PPF is not the same as a CPF or EPF in countries such as Singapore or Malaysia – where a provident fund is required).
Presuming that the PPF is not considered a PFIC, then the accrued but non-distributed interest and dividends could be immediately taxed by the US. Stated another way, there is no current exception as to immediate U.S. Tax liability for accrued but non-distributed PPF interest, dividends and gains.
Typically, a PPF is not necessarily a PFIC. A PFIC is a very complex type of analysis in which a foreign investment is considered a Passive Foreign Investment Company. For argument’s sake, presuming that a PPF was actually considered a PFIC (which is a stretch), then the income – unless distributed and considered in excess distribution – would not be immediately taxable as a grows within the fund.
But, presuming that the US person did not make a mark-to-market election, then down the line the taxability of the distributions would be significant.
The first distribution would be considered an excess distribution, which is then subject to a very high tax rate since it takes into consideration each year that the investment was growing but not distributed – and it is taxed at the highest ordinary income tax rate (not as qualified dividends). Therefore, even if the person was in the 15 or 25% tax rate, it would be taxed at 39.6% tax rate – with daily interest tacked on for good measure.
Typically, the tax rate would reach somewhere around 50% to 80%.
NRI and PPF
Recently, India has passed regulation, which states that if individuals have a PPF but are considered NRI (nonresidents of India), they have to close the PPF. In addition, the interest rate which oftentimes can reach as high as 10% — is reduced to 4%.
This can cause many issues with individuals were considered US person and NRIs and already out of compliance.
Large Transfer to the U.S. or FATCA Account
According to the FATCA agreement between India and the United States, there are some exemptions and exclusions for reporting, and in many situations this will include the PPF. With that said, the PPF is still required to be disclosed on the FBAR and FATCA by the individual (presuming all threshold requirements are met for reporting), even if the institution does not need to report.
This leads to bigger issues. While it may seem like a no-brainer to simply have your account closed and keep it’s existence hidden if it was not previously reported to the IRS or DOT — this could have some hidden dangers:
Bank FATCA Reporting
Once the PPF is closed, the money has to be transferred into another account. Most large institutions in India such as SBOI/SBI, ICICI, HDFC report regularly to the United States. If your account suddenly gets a large hit, which shows it was transferred in from one account or institution to another account, it could lead to further IRS inquiry as to:
- Where the money originated
- Why it wasn’t reported previously, and
- Why the income wasn’t reported
Unreported Foreign Income
If you are audited and the IRS inquires regarding the foreign accounts, they might find that you had money generating in the PPF. If in total, the amount of money generated from PPF and other account/assets exceeds $5000 annually, then the audit increases from three years to six years.
Therefore, if you did not properly report on form 8938 or the income generated from your foreign accounts/assets in prior years, you may be hit with additional penalties.
Get Into Compliance with IRS Voluntary Disclosure
One of the best methods for avoiding these issues in the future is to get into offshore compliance through one of the approved IRS offshore voluntary disclosure programs. This typically includes traditional OVDP, the Streamline Programs, or a reasonable cause statement.
Golding & Golding: About our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe. Our attorneys have worked with thousands of clients on offshore disclosure matters, including FATCA & FBAR.
Each case is led by a Board-Certified Tax Law Specialist with 20-years experience, and the entire matter (tax and legal) is handled by our team, in-house.
*Please beware of copycat tax and law firms misleading the public about their credentials and experience.