CA Abhinav Gulechha

Gift City Investments by US returnees – US/India Tax & FEMA implications

Last updated – December 31, 2025

US NRIs who are non-citizens non-domiciliary of US and plan to return to India and have significant investments back in the US and don’t want to move everything to India in INR suffer from the risk of estate tax on their US investments – basically their US-situs investments > USD 60000 are subject to an estate tax of 18-40% in case of a death. I’ve written in detail about estate tax risk here.  

There are strategies like liquidating & moving funds to India however the issue is that given the cap on global investments set by RBI by Indian mutual funds, there are very little options to invest globally from India. There are options to move funds to Ireland or retain US exposure and cover it by buying pure term insurance in India. With the advent of retail schemes in Gift city, one more route is getting opened for such NRIs to move funds out of the US and avoid estate tax however still retain funds in USD and get global diversification benefit rather than concentrating the fund in India.

Given the hype around Gift City as a tax-free global investing hub and given the confusion & FOMO in minds of returnees from US on whether to invest in Gift City vis a vis other avenues like Irish ETFs, in this post, I am discussing this topic from the point of view of US returnees and from a US and India Tax and FEMA perspective only.

India Tax Implications

We need to understand the tax implications from the point of view of whether person invests at the time of his location in US (qualifying as a non-resident as per Indian tax law) vis a vis after return to India (qualifying as a resident as per Indian tax law)

For Non-Residents of India –

Relevant sections under Income Tax Act as follows- 

  • Section 10(4E) – Exemption under for income from transfer of specified derivatives on IFSC exchanges
  • Section 10(4G) – Exemption given under of Income Tax Act on any income from portfolio of securities or financial products or fund managed by IFSCA approved fund manager.
  • Section 10(15) – Exemption under on income from interest by an IFSC unit
  • Section 10(10D) – Exemption under on proceeds received from a life insurance issued by an IFSC unit (applies to residents also)
  • Section 115A – Dividend income from certain IFSC units (having business approved for setting up in SEZ) taxable at a reduced rate of 10%

So practically w.r.t. investment income (interest/dividend/capital gain) from bank accounts, PMS schemes, or retail schemes may be exempt for non-residents.  However, as regards investments in AIF, for Cat 1& 2 AIF the income will be taxable to non-resident unit holder basis normal provisions of the Income Tax Act for non-residents or rates as per the India US DTAA whichever is more beneficial.

So, as an example, for a US resident investor, whereas the interest income (on foreign currency debt) is taxable at 20% under normal provisions of the Act and Article 11 of the DTAA specifies a 15% rate, the US investor may claim a 15% rate of taxation in India subject to submission of relevant documentation/TRC etc.

Under Section 194LBB, AIF has an obligation to withhold tax as per rates in force/reduced rate as per DTAA as applicable.

For Residents of India

As income from IFSC unit is treated as Indian income from tax purposes and there is no specific exemption given to residents, there is no change in taxation for residents and pretty much the same tax rules as with other incomes (equity shares, bonds etc.) apply to Gift City income as well. There is also no distinction between taxation in RNOR vs ROR status. Some points as below –

  1. Since Gift City is not expressly considered to be outside the definition of India under the Income Tax Act, investments in Gift City units do not qualify as foreign assets hence no requirement of disclosure of foreign assets in Schedule FA in ROR status.  
  2. Since Gift City investment is considered part of LRS under FEMA for an Indian resident, a Tax Collected at Source (TCS) of 20% shall apply for any investment by an Indian tax resident > INR 10 lacs in a financial year.
  3. Section 10(10D) – Exemption under on proceeds received from a life insurance issued by an IFSC unit
  4. Income from Alternate Investment Fund (AIF) as below:
  5. Cat 1 & Cat 2 – Treated as “Investment Fund” and specific provision for taxation in terms of Section 115UA read with Section 10(23FBA). Investment Income is not taxed in hands of AIF and is passed through to the investor. Income characterisation in hands of unit holder shall be same as that of the AIF. Business income continues to be taxable in hands of AIF (at rates as per Finance Act for company/firm or MMR in case of trust structure).
  6. Cat 3 – No specific taxation mechanism given in the Act. Taxation for the entity is as per the normal provisions of the Act depending on the entity type of the AIF (company/firm/trust etc.). No tax pass through to the unit holder. An exemption from taxation at unit holder level under Section 10(23FBC) only if certain conditions are satisfied (Cat III AIF/Retail Scheme/ETF & Non-Resident Unitholders) else also taxable at unitholder level.

Under Section 194LBB, AIF has an obligation to withhold tax at 10%.

India FEMA Law Implications

Relevant extract from FEM (IFSC) Regulations below –

“..

  1. Any financial institution or branch of a financial institution set up in the IFSC and permitted/recognised as such by the Government of India or a Regulatory Authority shall be treated as a person resident outside India.

…

  • Subject to the provisions of Section 1(3) of the Act, and save as otherwise provided in these Regulations or any other Regulations or directed by the Reserve Bank of India from time to time, nothing contained in any other regulations shall apply to a financial institution or branch of a financial institution set up in an IFSC.

..”

Relevant extract from the RBI Master Direction on LRS as below –

“..

11. Authorised Persons may facilitate11 remittances to International Financial Services Centres (IFSCs) in India for all permissible purposes under LRS for (i) availing financial services or financial products as per the International Financial Services Centres Authority Act, 2019 within IFSCs; and (ii) all current or capital account transactions, in any other foreign jurisdiction (other than IFSCs) through a foreign currency account held in IFSCs. Resident individuals may open12 Foreign Currency Account (FCA) in IFSCs for these permissible purposes. Resident individuals shall not settle13 any domestic transactions with other residents through these FCAs held in IFSC.

..”

Relevant extract from the Foreign Exchange Management (Overseas Investment) Rules, 2022 as below –

Schedule V [See rule 15] Overseas Investment in IFSC by person resident in India

“..

1. Overseas Investment in IFSC by person resident in India –

(1) Subject to the provisions of these rules and the Foreign Exchange Management (Overseas Investment) Regulations, 2022, a person resident in India may make Overseas Investment in an IFSC in India within the limits provided in these rules.

(2) A person resident in India may make Overseas Investment in an IFSC in the manner as laid down in Schedule I or Schedule II or Schedule III or Schedule IV: Provided that – (i) in the case of an ODI made in an IFSC, the approval by the financial services regulator concerned, wherever applicable, shall be decided within forty-five days from the date of application complete in all respects failing which it shall be deemed to be approved; (ii) an Indian entity not engaged in financial services activity in India, making ODI in a foreign entity, which is directly or indirectly engaged in financial services activity, except banking or insurance, who does not meet the net profit condition as required under these rules, may make ODI in an IFSC. (iii) a person resident in India may make contribution to an investment fund or vehicle set up in an IFSC as OPI; (iv) a resident individual may make ODI in a foreign entity, including an entity engaged in financial services activity, (except in banking and insurance), in IFSC if such entity does not have subsidiary or step-down subsidiary outside IFSC where the resident individual has control in the foreign entity.

(3) A recognised stock exchange in the IFSC shall be treated as a recognised stock exchange outside India for the purpose of these rules.

..”

Key points from above: 

  1. Financial institutions in Gift city do shall be treated as a person resident outside India. Accordingly, in my view, any investment made to the fund by a non-resident from his earnings as a non-resident should be protected under Section 6(4) of FEMA.   
  2. Investment as a Non-Resident as per FEMA in Gift City – FEMA law restrictions does not come into play here as the investment is by a non-resident investor into a non-resident FI. So, Investments made by US resident directly into a Gift city fund (without routing funds via the Indian bank account) should, in my view, be protected under Section 6(4) of FEMA wherein the person can retain the funds in Gift City indefinitely or reinvest them outside India (say move to UAE) without a restriction to repatriate to India. It will be helpful if RBI can provide a specific clarification to this effect.
  3. As a Resident as per FEMA – Investment via Gift city will be treated as Overseas Portfolio Investment (OPI) and be subject to a LRS cap of USD 2,50,000 per annum. While RBI circular dated April 26, 2023 while amending previous circular on the subject removed the condition of repatriating any funds lying idle in the account for a period up to 15 days from the date of its receipt it has expressly said that the LRS Master Direction will govern the same and the LRS rules specify a timeline of 180 days so in my view the same will apply to funds in Gift City bank account as well.

US Tax Implications

For a US person (USC/GC/ resident) –

The income from the investments will be taxable to a USC/GC and flow into your 1040 irrespective of the place where the person stays/resides and even if the income is tax free to you under Indian tax law.

Characterisationof incomeshall be determined as perprovisions under US tax law and any categorisation in AIF statement/under Indian tax law shall be immaterial.

Since pooling of financial interests is involved in such structures, a very relevant question for a US investor is that since pooled investment is involved, will the Indian fund structure (mostly AIF) would attract PFIC regulations in the US. This is given the very harsh and punitive tax and reporting consequences of a PFIC in US.

The definition of PFIC is given in Section 1297 of IRC as follows –

“(a)In general

For purposes of this part, except as otherwise provided in this subpart, the term “passive foreign investment company” means any foreign corporation if—

  • 75 percent or more of the gross income of such corporation for the taxable year is passive income, or
  • the average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.

….”

As we can see above, the entity needs to be qualified as a “corporation” for it to qualify as a PFIC.

Since an Indian AIF can be categorised as a company/LLP/trust structure, the question then is, is every AIF scheme qualified as a PFIC or some (especially those structured as a trust or an LLP) are not.

Important thing to note here is that the characterisation of the AIF as per Indian laws has no relevance for the characterisation as per US Internal Revenue Code, and a very detailed and complex guidance in given in CFR w.r.t. business classification rules in CFR 301.7701 – 1 to 8 – https://www.law.cornell.edu/cfr/text/26/301.7701-1

For example, under the rules. a trust which is mostly organised as an investment trust (and not a closely held trust with sole purpose to protect and preserve wealth of beneficiaries say minor children) or a partnership where members have limited liability will qualify as a corporation.

In some cases, an election can be made under Form 8832 and in some cases, not.  Hence, PFIC classification is the single biggest risk for a US investor investing in Gift City & investor needs to get a thorough examination of these rules to come at a conclusion on whether the AIF is a corporation or not and hence a PFIC or not.

If the AIF qualifies as a PFIC, then a very complicated set of tax and reporting requirements follow for the US investor – I’ve written on this topic in detail here. If the AIF does not qualify as a PFIC and say qualifies as a partnership, then the investor needs to ensure incorporating Schedule K1 income in personal tax returns, and check for applicable compliances like filing Form 8865 etc.

Investments will also count towards FBAR & Form 8938 thresholds and will be treated as part of taxable estate for US estate tax purposes if the person is a US Citizen/domiciliary under US estate tax law.

Non-US person – For a non-US person, a US tax obligation may only arise in a situation of the fund in which he/she has invested earns a US-sourced income. Further, the fund’s entity classification under US law (as a corporation/partnership) and characterisation of income (as a FDAP/ECI income) need to be checked. Generally, if the entity classification is corporation wherein the corporation pays tax in US and the unitholder earns a FDAP-style income (interest, dividend etc., not rental income etc.) wherein full withholding (generally 30%) is done at the fund level, no further US tax filing obligation may be needed. Detailed fact analysis is needed to come at a clear conclusion.  

Other points

  1. Estate laws of India should apply on the funds in Gift City as the domicile of the corporation issuing the securities is India. It is advisable to make proper nominations & also update Indian will to include Gift city investment details as appropriate.  
  2. Under Rule 114AAB of Income Tax Rules in India, a non-resident does not have to have a PAN. Since FEMA does not apply, the person need not have an NRO/NRE bank account, PIS demat account etc.
  3. Under Indian tax law, Cat 1 & 2 AIFs have an obligation to provide a statement to the unit holders in Form 64C & 64D giving details of nature of income.

Some Issues/Grey areas

  1. For a US returnee, investing directly into Gift city vs bringing into an Indian resident account & then sending to Gift city – In my view former is any day preferable as in the latter case, the LRS restrictions clearly become effective for those funds.
  2. For Category 3 AIFs where income is taxed at fund level in India, there is no regulatory clarity as to at what rate the income will be taxed (capital gains/business income), which can give rise to the presumption that since the AIF which are mostly incorporated as trust structures carrying on a business of buying/selling securities, the taxation on the gain maybe at a maximum marginal rate – the fund return will be net of this tax and to that extent, the end investor returns will be affected – this issue should be clarified by the Indian tax office.
  3. Again, for Cat 3 AIF, since tax has been paid by AIF and there is no obligation under Indian law to provide a statement on income, if and how should the end investor (say a US resident who also pays taxes in the US) show the income in her 1040 – How the income and tax portion be segregated in absence of documentation? Should she gross up the income (include the tax component) and claim FTC of Indian tax or show the income net of India tax as received by her? In former option, can FTC claim be even allowed since tax is paid by AIF and not by investor?
  4. In case of investment by US persons in closely-held AIF structures in Gift City, there may be an overlap between the PFIC and CFC rules given the separate rules on ownership and income attribution which are highly complex and requires a detailed study – the US tax implications and reporting will also differ depending on the categorisation.
  5. For Cat 1& 2 AIFs where the loss is passed through to the unitholder, can the unitholder claim this loss as a setoff against other US income for US tax purposes?
  6. For AIF (especially those incorporated in trust structures), there is a lack of clarity on the distinction of income as business income or capital gains – this is pertinent as business income in case of an AIF incorporated as trust is taxable at MMR in hands of AIF (even Cat 1 & 2) and hence can have a significantly impact on the return at the end of unit holders.
  7. As from what I read online, some Gift City schemes are only for non-residents so after your return to India, your investment may be mandatorily redeemed by the fund – NRI Investors planning to invest but have R2I plans should read Offer Documentation clearly on this point.
  8. US returnees who continue to work in India in the Indian arm of US corporations and continue to receive stock compensation in form of RSU of US co. shares, please note that the RSUs received reduce your available LRS limit for investing in Gift City so one needs to plan accordingly.

Gift City Investment by US returnees – Pros and Cons

Pros

  1. No PAN/PIS account requirement for non-residents
  2. Section 6(4) protection under FEMA on the funds
  3. No US estate tax risk for non-USC/domiciliary on funds shifted out of the US & invested in Gift City
  4. No USD 1 Mn limit & Form 15CA & CB for repatriating funds outside India for non-resident investors (as applicable in Indian NRO accounts)
  5. Funds stay within India & governed by Indian succession laws – can be part of an Indian will – in event of investor’s death, may be easier for family to co-ordinate with “Indian” customer support/professionals regarding payout formalities

Cons

  1. Unstable regime – Risk of change of tax rates & regulatory framework by Indian govt.
  2. Lack of sufficient investment options for retail investors + possible high-ticket size and expense ratio in the schemes
  3. High fund manager risk (given the lack of long enough performance track record)
  4. Indian tax residents may face taxation on the investments  
  5. Investment process may be largely manual till things get automated

Thought pointers for US returnees on Gift City

  1. US residents should be very careful in taking an exposure to Gift City in view of the PFIC laws in US which in my view represent the single biggest risk in investing in these funds. Wherever possible, sufficient documentation as regards non-PFIC status must be asked from the fund and independent opinion should be sought via a CPA – ideally a written opinion from a CPA/tax attorney in US should be sought on the PFIC classification. In case of an IRS enquiry at a later stage, this opinion may (not always) help you meet the ‘reasonable cause standard’ and protect you from penalties if any. 
  2. A decision on which ETF to invest should not be basis the tax nature of the funds – For example, Cat 3 AIFs are being touted as tax free investment which is completely incorrect. Since tax applies at fund level, hence is borne by unitholder in terms of reduced NAV.
  3. The real case for a Gift city may not be returns but risk reduction – since the schemes are allowed to practice several strategies like long/short and alternative asset strategies which have a low beta relative to long equity, allocating a small part of overall portfolio to these investments can reduce the overall risk of the portfolio (especially if major part of your portfolio is long on equity as an asset class, which I see very commonly in US returnees who hold significant wealth in company stock). Hence, for someone who is looking to invest should consult an independent registered investment adviser (RIA) on the “investment strategy” aspect and whether there exists a strong case to include that strategy in your portfolio
  4. For a US returnee who wants to avoid US estate tax and still retain a USD exposure in US companies, Gift City route need to be compared to Irish ETFs also  – Irish ETFs, backed by a very strong regulatory structure in form of UCITS, a reputable & stable jurisdiction for global investments in Ireland with very clear and straightforward taxation regime unlike grey areas in the Gift city regime and a much lower ticket size, can pose a significant competition. Proper independent investment advice may be considered in view of the complex nature of decision. You can read my detailed post on Irish ETFs here
  5. NRIs considering Gift City should watch out for the scheme restrictions of the scheme open only for NRIs especially in Cat III AIFs – that means that when someone returns to India, the fund value will be paid out. This has its reasoning in exemption at unit holder level under Section 10(23FBC) of Income Tax Act – the unitholders of AIF become ineligible for this exemption if units held by non-residents are not at least 95% of the total units.
  6. One needs to keep in mind that Gift City, though not a part of India from a FEMA perspective, does fall a part of India from an Indian Income tax perspective. This means that the Gift City does not have its own tax code or something and the tax rules fall part of Income Tax Act only and hence can be changed at a whim by the Government by way of annual Finance Act, similar to how indexation benefit was suddenly removed in 2024 and a partly restoration for real property gains after a public uproar. Jurisdictions like US, Ireland, Singapore may be much more stable and predictable in that context. Hence keeping a portion of investments outside India and outside Indian taxation system can be a good regulatory hedge. Also, under the existing tax system in India, there is still a lack of clarity on certain tax benefits & regulatory aspects – for example, the ULIP tax arbitrage may be plugged anytime.  
  7. Retail schemes in Gift City are slow to come with majorly AIF format with very high-ticket size which are more suited only for HNW investors – so as compared to US or Ireland markets with low-cost ETFs with varying investment themes, there is a far less choice in Gift City and the fund manager risk is high given no or very little performance track record of the schemes.  
  8. As regards Gift City FD, one needs to see the comparative tax benefit against FCNR (if non-resident)/RFC (if resident) – for example, RFC interest is exempt till RNOR under ITA but no similar exemption provision exists for fixed deposits in IFSC.
  9. As regards Gift City ULIP policies, the product nature of ULIP is generally not a recommended structure as insurance and investments should be kept separate. The ULIP arbitrage that a IFSC insurance policy presently holds may be plugged by a Finance Act amendment so that should not be solely the reason for the investment.

Conclusion

Gift city at this time may be attractive for NRIs from countries who do not have personal tax like UAE. However NRIs from US who are subject to very complex PFIC and foreign information reporting, Gift City requires a very careful consideration and diligence. For Indian tax residents, there seems to be no tax incentive as such except Gift city being an avenue for global diversification with overseas mutual fund route being closed. US returnees need to closely weigh Gift City vis a vis other estate tax mitigation strategies like Irish ETFs and pure term insurance in consultation with their advisers before taking the leap.

Further reading –

Gift City website

Taxmann webinar on Gift City taxation

Thanks for your kind reading and hope the post has been useful to you. Please share thoughts/feedback in comments section. Thanks.

Copyright © Abhinav Gulechha. This article is my original work. Excerpts may be shared with proper attribution and link to the source. The content is for general informational purposes only and does not constitute legal, tax, or professional advice. Laws and interpretations may change, and outcomes depend on individual facts. Readers should consult their own advisors before acting on any information herein.

Posted

in

, , , , ,

by

CA Abhinav Gulechha

Tags:

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *