Disclaimer:
- I am not an expert on tax & succession laws applicable to jurisdictions outside India. Those aspects need a careful consideration and you should consult a CPA in that regard.
- I am not associated with entities named in the post in any way, nor have I been paid by these entities or third party to do this post.
- Overseas diversification may not make sense if your investment portfolio is small and/or you do not have overseas financial goals/ plans to move outside India.
Over a period of time in my work as an investment adviser, I have realised the importance of diversification & asset allocation (not only between asset classes but geographically as well) and the importance of super low cost investment avenues like index funds.
In case of NRI portfolios, a huge chunk of the portfolio is invested in India. This is because the family may be planning to retire back in India and hence wants to keep everything in INR, and the yields that are on offer in India is much higher than anywhere else in the world.
However, for an NRI, while India is a premier offshore destination for investing, in this post I wish to make a serious case for investing in jurisdictions other than India.
When you speak about offshore, there are only two markets that I advise one to invest: first is obviously India, and second one is USA. So, while this post is all about USA, a lot of the content in this post (especially Indian regulatory requirement related) applies to non-USA investing as well.
Thus, in this post, I will share on how NRI families can invest in USA, the regulatory & other implications, challenges etc.
Reason for Overseas Investing
Following main reasons for this as follows:
#1: Geographical Diversification
There is a general tendency to invest entire portfolio in a country which has historically given the best returns. And where globally you have gloom and doom, the only shining spot is India. And the premise behind investing in India is that the growth story will keep running unabated. It may play out true, it may not.
Given the low correlation between India and US equity and currency markets, what investing outside India does it is that it reduces the volatility in the portfolio and makes it more balanced.
#2: Better way to plan offshore financial goals
Times are changing. With increasing mobility of talent across the globe, cross border employment is not a special thing. After seeing the kind of lifestyle, education etc. outside India, some people decide to settle outside India. Even those who come back decide to send their kids abroad.
Even for families who are resident in India, there is a growing tendency to send kids to USA.
When a family has a goal of either settling outside India, or an education funding goal in a country say USA, it is not a correct approach to keep entire investment portfolio in India for the reason of good yields etc.
In such a case, the investment portfolio remains exposed to currency risk. I have discussed in detail about currency risk in my post: How NRI/PIO families can manage exchange rate risk in their investments
#3: Protect from risk of arbitrary changes in local foreign exchange policies
Every country has a policy to control the money movement – In India, we have FEMA and regulator is RBI. The regulator has powers to increase/decrease the limits on how much can be sent out of India, or how much can come to India.
Let us understand by way of classic example: As we know, there is a Liberalised Remittance Scheme where presently resident Indians can send upto USD 2,50,000 per financial year outside India – in the currency crisis in April 2013, the RBI abruptly reduced the limit to USD 75,000 in a bid to reduce the fall of the rupee.
In such a situation, if you have financial goals which require you to send money outside India, you can be caught on the wrong foot, and so another reason to keep some part of the investment portfolio offshore.
Now, speaking of US citizens/ Green Card holders/ Resident Aliens in USA, they can pick up any good Vanguard fund and invest in it. However, it becomes tricky when you are a resident Indian or non-USA based NRI.
Is international investing allowed under FEMA?
India’s foreign exchange law FEMA may come into play in such transactions and hence one has to comply with it. The rules are different depending upon whether you are a person resident in India (RII) or person resident outside India (ROI) as per FEMA.
I have written in detail on residential status as per FEMA in this post: NRI Definition: FEMA Act VS Income Tax Act
Rule for Person Resident of India (RII):
Investing in foreign securities for an RII as per FEMA constitutes a permitted capital account transaction as per Schedule II of FEM (Permissible Capital Account Transactions) Regulations, 2000.
I have written in detail on capital and current account transactions in FEMA in this post: Capital and Current Account Transaction as per FEMA
However, such a person can only invest upto USD 2,50,000 per year, which is otherwise known as Liberalised Remittance Scheme. Investment in foreign securities is a permissible under the LRS. Though USD 2,50,000 is a big enough limit, in case you wish to invest more, you need to seek prior approval from RBI.
I have written in detail on LRS in this post: Liberalised Remittance Scheme (LRS) under FEMA: Analysis & Issues
Now there might be a question: what happens if such an resident moves out of India?
In such a case, such person becomes ROI as per FEMA. Good news is, that he can keep the investments out of India and make further investments WITHOUT ANY LIMIT since the restrictions on RII applicable on him when he was an RII no more apply to him now as he is a ROI.
Rules for Person Resident Out of India (RII):
For a person resident out of India, investment in US stocks will NOT qualify as a capital account transaction and will thus be allowed without ANY limit.
So, an NRI can open offshore bank accounts, demat accounts, invest in foreign stocks comfortably without worrying about FEMA.
Now there might be a question: what happens if such an NRI returns back to India?
In such a case, he will qualify as a RII and the restrictions that apply to RII will apply to him. He cannot invest more than the LRS limit per year outside India.
However, good news is that by virtue of Section 6(4) of FEMA, for the investments and accounts opened by him outside India, he can maintain them outside India and need not liquidate & bring them to India.
Where to invest in USA
USA is one of the most developed economies and there are a lot of investment options.
However, speaking about portfolio diversification, I would essentially want to diversify a portion of the equity component of my portfolio into overseas investments.
And when I speak about overseas investments, I would not suggest you to look beyond Vanguard funds.
WHY Vanguard? I think this link will explain: Link. The biggest advantage I see in investing my money in Vanguard is its super low expense ratio, and more importantly, the fact that it allows me to hold the entire breadth of the S&P 500.
Option # 1: Investing directly with Vanguard in USA
First thing to understand here is that you need to be a US person to invest through Vanguard. It requires following mandatory details when you invest through it:
- Social Security number.
- Birth date.
- E-mail address.
- U.S. street address.
- Employer name and address.
Only a US citizen, Permanent Resident (GC holder) or a Resident Alien can open an account with Vanguard. Non-resident aliens cannot.
So, it works like this:
- If you’re a US citizen/ GC holder, you can live and work anywhere & open an account, no questions asked.
- If you’re NOT a US citizen/ GC holder but are living and working in USA, you qualify as resident alien and can open an account.
- If you’re NOT a US citizen/ GC holder and do NOT live and work in USA, you qualify as a non resident alien and hence CANNOT open an account with Vanguard. So, a resident Indian or a non-USA based NRI cannot invest in Vanguard directly.
Also read: USA based NRIs: Know about IRS tax residency rules
Option # 2: Invest in a Vanguard ETF
Dont lose heart! For those like me who cannot invest directly, second option is to invest in ETF of Vanguard which are listed on the New York Stock Exchage (NYSE).
Speaking of ETFs, Vanguard has many ETFs – my recommendation will be Vanguard S&P 500 ETF (Code: VOO) Link
This is the simplest and plain vanilla ETF that mirrors S&P 500 and has a rock bottom expense ratio of 0.05%
The question is, how to go about buying it.
The basic principle for purchasing a security on any exchange, you need to open a demat account with a broker.
Option 2(A): Invest through your Indian broker:
For a resident Indian/ NRI who already has a demat account with a DP say ICICI Direct, he needs to check whether the broker has a tie-up with an overseas broker who is authorised to transact on NYSE.
In this regard, over the past few days, I had written to more than 10 DPs – some like Motilal Oswal, Kotak and Zerodha have expressly told that they don’t allow overseas trading and I am yet to receive a revert from ICICI and others – will update here as and when I get the info.
One peculiar thing I’ve noted is that Indian brokers who had in the past tied up with overseas brokers (mostly Saxo Bank) have cancelled their tie ups. An example is Kotak: they started offering it, then stopped it – amusingly, it is still reflected on their website Link
In this backdrop, it is a real disadvantage for an investor if the Indian broker cancels the tie-up – in such a situation, I don’t know how the servicing/transitioning aspect is taken care of.
Option 2(B): Open account with an international/local broker in USA:
In my view, a better option is to open an account directly with a broker in USA that offer international trading facility to non-USA persons or an international broker that is registered in multiple jurisdictions.
In my research, Charles Schwab, TD Ameritrade and Interactive Brokers came out as options that can be considered for further analysis. However, there are many other international brokers and one can do further research on those as well.
Charles Schwab Link
- Minimum Deposit to open account: USD 25,000
- Minimum Deposit at any time: USD 1000
- Charges per online trade (stock/ETF): USD 8.95
- For complete details on fee Link
- For documents required to open account Link
- In the Form W8-BEN, you can specify a reduced withholding rate as applicable under the DTAA of your country of tax residence and USA.
- You can fill the online form and despatch it to the Schwab office at Texas, USA
Similar info on other brokers can accessed by visiting their websites as below:
Option # 3: Invest through Indian MF/ETF route
If you cannot meet the minimum ticket size requirements of international brokers, don’t fret. There are good number of international mutual funds & ETFs in India, some of which are dedicated USA ones.
Some examples are listed below along with the link for further information:
- MOSt Shares Nasdaq 100 ETF Link
- ICICI Prudential US Bluechip equity fund Link
- Franklin India Feeder – Franklin US Opportunities Fund Link
- As compared to an ETF, if you invest in a mutual fund, you can also invest through the SIP route and do not need a demat account.
If your objective is to just diversify your portfolio and get a US exposure, you can go invest in these funds without directly investing in USA.
However, the disadvantages in investing through Indian MF/ETF are as follows:
- Your funds are still denominated in INR only though to a certain extent, exchange risk does get minimised.
- The expense ratios are on a higher side – if investing through mutual funds, advisable to purchase directly from AMC and purchase “direct” plan
In this context, I need to make a special mention about Parag Parikh Long Term Equity Fund which is a pure equity fund for tax purposes as well BUT allows upto 35% exposure to US stocks.
Investors who prefer tax free capital gains through equity mutual funds in india however want some international exposure can look at making this fund a core holding in their portfolio.
Small downside in this fund is that its expense ratio is on the higher side which is expected to come down with increase in fund size.
Tax Implications of overseas investing
#1: Direct purchase of mutual fund/ETF in USA:
You will have to provide form W8-BEN to your broker at the time of opening the account where you can mention your tax residency status and a lower withholding rate. Your broker will deduct withholding tax on the dividends and any realised gain paid out by the mutual fund/ ETF.
If you qualify as a resident as per Indian tax law, you will have to add the income from this investment in your tax return and you can claim the tax withheld in USA as a credit. You should preserve the investment statement and W-2 form in your tax file, to present to Income Tax Authorities if asked to substantiate the foreign tax credit at a later date.
If you qualify as a non-resident as per Indian tax law, there is NO tax implications for you as far as your Indian tax returns are concerned – you do not need to disclose the income arising from the ETF in your tax return in India. Even if you file a return in India, you can disclose it under exempt income schedule.
However, as NRI you must be aware of the tax law of your host country as to whether it will tax that income since you’re a tax resident of that country – also you’ll have to check if there is a DTAA between USA and that country so that you can claim a lower withholding tax or a tax credit – for that, you can engage with a CPA/tax adviser in that country.
#1: Purchase via Indian MF/ETF:
The international MF/ETF (examples of Motilal, ICICI and Franklin given above) are treated as debt funds for tax purposes which mean that any holding of less than 3 years results in short term capital gain being taxable as per your tax slab & holding period > 3 years is taxable at 20% with indexation benefit.
If you are a non-resident as per tax law, the provisions are exactly the same only that unlike resident where no TDS is applicable, here there will be a TDS implication of 30% or 20% for holding period of less than and more than 3 years respectively.
Black Money Law Implications
As per Black Money law, any person who is Resident and Ordinarily Resident (ROR) in India need to disclose the foreign assets in the tax return. This information is generally required to be filled in the Schedule FA in the income tax return.
To find out your exact residential status, read this post: How NRI/PIOs can decode the Indian tax residency rules & save tax
So, if are ROR, you will need to disclose the details of ETF as well demat account and bank account in USA, if any. Penal implications for non-disclosure are severe and you can even end up in jail.
There is no requirement to disclose such investments as long as you are an NRI or a Resident and Not Ordinarily Resident.
Will and Nomination aspects
When you create an asset outside India, it is important to nominate your spouse or a family member to those assets. Also, it is advisable to add details of that asset to your will in India as well as outside India.
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