A lot of skilled workforce from India migrates to the USA every year in search of better career opportunities. Given the US government’s policy stance of having in place a culturally diverse population, a sub-set of migrant Indian community do apply & qualify for a US citizenship after a few years of stay in the USA.
On the financial front, once you become a US person, irrespective of the place of stay in the world, you fall in the net of IRS tax rules. These people may have either already invested in Indian mutual funds before becoming a US person or wish to do so now to participate in India’s growth story. Important thing to note here is that IRS treats such foreign investments as Passive Foreign Investment Company (PFIC) & has prescribed a comprehensive and extremely complex set of rules on the same. Indian mutual funds mostly qualify as PFIC for IRS purposes.
Tax consequences for PFIC
Once the asset qualifies as a PFIC, following tax consequences follow:
- Tax treatment of a PFIC under the IRS rules is highly punitive and is aimed at prohibiting any deferral of tax liability. Thus, the rules require a US person to disclose any unrealised gain from the Indian mutual fund as ordinary income and pay tax on it every year in the tax return.
- A separate annual reporting is applicable for each PFIC investment in Form 8621, and this reporting requirement is independent of the applicable tax return and reporting in Form 8938.
- Even if the asset was purchased BEFORE you became US person, there is no respite and these rules kick in from the tax year one becomes a US person.
Given the above, how can a US person invest in Indian equity
Stable macros and growth promise that India offers vis a vis other developed and emerging markets are strong reasons for informed overseas investors to invest in India. Also, for a family having a long term plan of returning back to India, they may wish to invest a part of their total investment corpus in India to build a rupee portfolio. So, the million dollar question for a US person wanting to invest in India is: How can I take part in the India growth story without breaking my head on the complex IRS requirements?
From my limited experience, some of the options I can think of and wish to put across as thought pointers are as follows:
#1: Invest in dedicated India mutual funds in USA:
There are dedicated mutual fund schemes in the USA which invest almost fully in Indian equity. From the 18 odd mutual fund schemes, Matthews India Fund is the largest India fund in USA with $1.48 bn in assets and promises a very low portfolio turnover, low expense ratio, lower volatility due to a bent towards large cap and a 10+ year strong track record of performance. Wasatch Emerging India Fund can be another good choice. Though it is a relatively young fund, a clear small cap focus and an impressive benchmark beating performance makes it a strong contender. Note that for these investments, since the underlying currency is US Dollar, following this approach carries a currency risk which is especially relevant for those planning to return back to India for good.
#2: Directly invest in stocks in India:
Another option is to directly invest in Indian stocks through a Portfolio Investment Scheme (PIS) demat and trading account. You can pick up a fairly concentrated multi-cap fund of your choice or an index like the Nifty Quality 30 as a base and then mimic and periodically re-align your portfolio to the holdings in that fund/index. This, apart from being a very cumbersome approach, contains a residual risk of PFIC non-compliance: there is no guarantee that an individual stock does not fall in the PFIC definition and it depends on a case to case basis. So, best approach is to consult a CPA/ tax adviser before proceeding.
#3: Gifting money to relatives in India:
Another workaround is where a US person may gift money to relatives (e.g. parents) in India which the parents can invest in equity mutual funds in their name and after some years, basis a mutual understanding, redeem and gift the money back to such a person. Under the IRS rules, given the high enough lifetime exclusion limit of $54,50,000 (for 2016), practically there will be no tax implication on the giver (i.e. the US person). Under Section 56 of the Indian Income Tax Act, gift received from “relatives” irrespective of amount is tax free in the hands of receiver. If one chooses this option, one has to be very meticulous in ensuring proper documentation via a formal gift deed and also maintain sufficient backup documentation for US tax payments and the source of funds for the gift, so as to produce to either country’s tax authorities in case of a tax scrutiny/detailed audit. Note that if the amount of gift exceeds the annual exclusion limit of $14,000 per donee per tax year, a reporting (no tax if within lifetime exclusion limit) is required in Form 709 under the IRS rules. Apart from the above, the advisor need to also impress upon the client that since “gift” is an irrevocable transaction, in case of family equations turning sour later on, it may be impossible to reclaim ownership of the asset hence discretion is required.
#4: Re-think on your US citizenship:
Life’s priorities change with time and people who had otherwise decided to spend their last breath in USA while applying for US citizenship do change their mind and return back to India. While a US citizenship is a lifetime asset & carries its own benefits, looking from the point of view of outside USA investments and especially for those who’ve returned back to India for good, retaining a US citizenship can prove to be a big hurdle. As per news reports, in past couple of years, stringent IRS rules and FATCA obligations, have made many families take the hard decision to relinquish their US citizenship. There is no single answer and one needs to do a dispassionate analysis of pros and cons of retaining US citizenship w.r.t. long term life plans and take a decision on the same.
Conclusion
Earlier, in absence of any information exchange agreement between countries, it was easy for US persons to hide the details of these Indian investments from the IRS but now with India entering an Inter Governmental Agreement with USA under FATCA last year, and given IRS’s increased scrutiny on offshore assets, it’s a wake-up call for US based Indians to set their financial affairs in order and also for the investment advisors to bring this to the notice of their clients who possess such investments.
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