Have you invested in foreign stocks to diversify your investment portfolio? If yes, irrespective of whether you are a beginner or an experienced investor, you must comply with the tax rules. The government taxes the gains from foreign investments differently than that of capital gains from domestic investments.
Under the exchange control regulations, RBI permits and regulates the investment in foreign companies through many routes like - direct investment, Liberalised Remittance Scheme (LRS), Overseas Direct Investment (ODI), etc. The investor will have to comply with these regulations laid down by the Government of India.
On the tax front, the Income Tax Act has laid down residency rules that determine the taxpayer's residential status. Determination of the residential status is the first step towards understanding the tax implication on the gains from foreign investments.
The Income Tax Act has laid down three categories of residential status of individuals, namely:
The residential status mentioned above is to be derived based on the number of days of an individual's presence in India during the relevant year and previous years as per the rules laid down in the Income Tax Act.
The primary sources of income from foreign investments can be:
Dividend income from foreign stocks
Dividend income from a foreign company will be added to the other sources of income and taxable at the taxpayer's applicable slab rate. For instance, if the taxpayer's income falls under the 30% tax slab rate, the dividend will also be taxable at 30% along with cess. Also, TDS rules may be applicable on the dividend income received. However, the investor can claim the tax credit of the TDS deducted in accordance with the double tax avoidance agreement (DTAA) between India and the respective country.
Capital gains on foreign stocks
Any gains arising on stocks not listed in India shall be treated similarly as unlisted shares. If there is an increase in the value of investment at the time of sale, then it results in capital gains and the investor is liable to pay taxes on it. Accordingly, the gains will be treated as long-term or short-term depending on the holding period of investment.
If the foreign company shares have a holding period of more than 24 months i.e 2 years, it will be considered as long-term capital gain. If the holding of such shares is less than 24 months then it will be considered as short-term capital gains.
Long-term capital gain from the sale of foreign stocks (not listed on Indian exchange) will be leviable at the flare rate of 20% plus health and education cess (plus surcharge, if applicable). Also, the indexation benefit will be available on the cost of the investment. Whereas short-term capital gain from the sale of foreign shares will be added to total income and taxable at the individual's slab rate.
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The investor should be mindful of the returns from the foreign stocks along with the impact of currency fluctuations, as the returns would be reduced to the extent of the tax and cess payable.
Capital gains on global mutual funds
Suppose an individual invests in global funds having exposure to foreign stocks. In that case, gains on redemption of these international funds depend on the extent of the funds' exposure in foreign stocks.
If the portion of Indian equity stock is above 65%, then the gains will be taxed like equity-oriented funds. It will be considered long-term capital gains if the holding is more than 12 months and taxed at 10% on gains above Rs.1 lakh per year. For funds held for less than 12 months, short-term capital gains will be taxable at 15%. Applicable cess will be levied on these gains.
Global funds with less than 65% exposure in Indian equity will be regarded as a non-equity fund and taxed accordingly. Investments in such funds with holdings more than three years will be considered long-term and taxed at the rate of 20% with the indexation benefit. Whereas holding of fewer than three years will be treated as short-term gains and taxed as per normal slab rate.
Double Tax Avoidance Agreement
The Indian Government has entered into the Double Tax Avoidance Agreement (DTAA) with more than 95 counties, which helps claim the tax credit in case of double taxation. In most of these double tax avoidance agreements, concessional tax is deducted on dividend income at the source.
DTAA usually offers reliefs by two methods (i) Exemption method (ii) Tax credit method. Exemption method taxes the income in one country and exempts it in the other. In contrast, the tax credit method allows the taxpayer to take the credit of the tax paid in one country from the tax liability arising in another country.
Hence, the investor should review India's double tax avoidance agreement with the respective country to get clarity on tax implications on the income from foreign stocks.
ITR filing
It should also be noted that if you have invested in foreign stocks, you will have to mandatorily file a tax return in India. Details like list of foreign assets, bank account, income earned from foreign investments, tax liability thereon, amount of foreign taxes paid and tax credit claimed under respective DTAA, etc is to be provided to the income tax department.
The Indian residents have to file the income tax return even if the individual does not have any taxable income during a particular year but holds a financial interest in an offshore entity. Individuals can file ITR-2 or ITR-3 based on the nature of income earned.
The author is Founder and CEO of ClearTax