SEBI’s strict instructions: Brokers and mutual funds should update KYC and tax reporting system immediately, wires related to new income tax rules

The Securities and Exchange Board of India (SEBI) has issued an important regulatory directive to enhance financial transparency in the country’s capital market and strengthen tax compliance at par with international standards. SEBI has directed all authorized market intermediaries, including stock brokers, depository participants, mutual fund houses (AMCs), portfolio managers (PMS) and custodians, to upgrade their ‘Know Your Customer’ (KYC) and tax reporting IT systems in line with the new income tax rules with immediate effect. Following amendments in direct tax laws and global information exchange treaties, the regulator has taken steps to ensure that genuine data of financial transactions and tax residential status of investors reaches the relevant authorities without any errors.

According to SEBI’s official circular, this direction is directly linked to the changes made in the reporting requirements under the Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) under the Income Tax Act and amended Income Tax Rules.

• Ban on global tax evasion: FATCA and CRS are an international framework aimed at preventing cross-border tax evasion and automated sharing of financial account information (AEOI) between global financial institutions.

• Compliance with CBDT Guidance Note: SEBI has advised all intermediaries to strictly follow the updated guidance note on FATCA and CRS issued by the Central Board of Direct Taxes (CBDT). Entities will have to re-configure their internal systems and data architecture so that accurate information required under the revised guidelines is sent to the reporting portal in a timely manner.

Broking platforms and mutual fund companies will have to make some significant changes in their onboarding workflow and customer database after SEBI ordered system upgradation:

1. Verification of tax residency and declaration: Self-Certification of tax residency status of investors (whether they are a taxpayer only in India or in any other country also) will be recorded more accurately while opening new demat or mutual fund accounts.

2. Strict scrutiny of high-value and NRI accounts: The verification mechanism for financial transactions, permanent address and Foreign Tax Identification Number (TIN) of Non-Resident Indians (NRIs), Overseas Citizens of India (OCI) and Foreign Investors (FPIs) will be tightened.

3. System Integration and Automation: Brokers and depositories will have to update their backend software so that the data received from the Central KYC Registry (CKYCR) and KYC Registration Agencies (KRA) can seamlessly sync with the Tax Information Network (TIN/Reporting Portal) of the Income Tax Department.

Regarding domestic retail investors, market experts say that there is no need to panic for ordinary Indian citizens, who have no tax liability outside India and whose KYC is already validated.

• However, for investors whose profiles have witnessed any recent change in residence, citizenship, foreign address or tax status, their broker or mutual fund house may request them to submit an updated FATCA/CRS self-declaration form.

• If an investor’s PAN card and tax records do not exactly match the Income Tax Department’s database, they may receive an alert to verify their details during the system upgrade.

SEBI has clarified that this technological upgradation is mandatory to maintain transparency in the capital market and comply with the provisions of the Prevention of Money Laundering Act (PMLA). All intermediaries are required to submit their system audit and compliance reports within the prescribed timelines. If a broker or financial institution fails to comply with the revised tax reporting standards or sends incorrect data, it may be subject to regulatory fines as well as punitive action under relevant sections of the Income Tax Act.