The article compares various investment options for US-based NRIs intending to invest in the Indian stock market.
This article is a part of our detailed article series on the concept of PFIC taxation rule applicable to US NRIs. Ensure you have read the other parts here:
How are US-based NRIs taxed on their investments in India
Case 1: Indian MF without repatriation
Case 2: Indian MF with repatriation
Case 3: US-domiciled ETF (Exchange-Traded Fund)
How much difference in returns will be there investing in the same stocks from the US vs in India?
Returns for a $1000 investmentJaipur Wealth Management
What should an US-based NRI do to invest in Indian stocks?
The IRS requires US tax residents to pay tax at their highest slab rate on investments in PFICs for every tax year (1st Jan to 31st Dec).
🛈 Who is a US tax resident?
Under the US Internal Revenue Code (Code), all US citizens and US residents are treated as US tax residents. For a non-U.S. citizen (alien individual) to be treated as a resident alien, they must satisfy either the green card test or the substantial presence test.Mumbai Stock Exchange
Source: OECD Website
Any NRI planning to stay in the US for some time will become a US tax resident after 183 days. The same rule applies to Green card holders as well.
🛈 What Is a Passive Foreign Investment Company (PFIC)?
A Passive foreign investment company (PFIC) is a foreign corporation for which either 75 percent or more of the gross income of the corporation for the taxable year is passive income, or the average percentage of assets 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.
Source: Cornell Law School
This tax is paid on unrealised gains. If your portfolio goes up by 10 lakhs a year, you pay 3 lakhs tax even if you did not sell anything
If we combine the above two definitions, any US-based NRI who is either a green-card holder or has stayed longer than 183 days in the US in a calendar year has to pay tax on Indian mutual funds, ETFs and AIFs (Cat 1 and Cat 3 only which do not have pass-through taxation). Direct stocks, real estate and provident fund (PPF/EPF) are not considered as a PFIC. This tax is paid on notional gains though you have not sold anything.
Warning: Taxes paid under PFIC are not refunded if you leave the US and come back to India. This rule will lead to severely lower returns on Indian mutual funds (and other PFIC eligible investments) in case you have paid the tax already.
A detailed primer on the concept of PFIC and related calculation is here: Should US-based NRIs sell off their mutual funds and stocks in India?.
This article will cover the return of investing in Indian stock market via two equivalent investments:
Dalal-street route: Indian Nifty 50 Index fund (Nifty MF in short)
Wall-street route: US-based ETF that invests in the Nifty 50 stocks in India (Nifty US ETF in short)
We will consider these cases:
Case 1: Investment in Nifty MF and the money is kept in India
Case 2: Investment in Nifty MF and the money is repatriated back to the US
Case 3: Investments in Nifty US ETF and the money is kept in the US
Investment Strategy: An investment approach where a US-based investor regularly invests funds in an Indian Nifty 50 index fund.
Tax Implications: Subject to PFIC rules, the investor pays tax on unrealised gains every year in the US at a combined (federal plus state) rate (assumed) of 32%. A 20% capital gains tax in India and the US under DTAA is paid on the final capital gains. If you have paid taxes in the US under PFIC, these will not be refunded in case you move back to India.
End Corpus: The invested funds remain in the Indian stock market and are not repatriated out of India.
Investment Strategy: An investment approach where a US-based investor regularly invests funds in an Indian Nifty 50 index fund.
Tax Implications: Subject to PFIC rules, the investor pays tax on unrealised gains every year in the US at a combined (federal plus state) rate of 32%. The final capital gains tax is 20%, just as the first option.
End Corpus: The invested funds are repatriated out of India at the end of the investment period.
Investment Strategy: Investment in the Indian stock market, specifically the stocks in the Nifty 50 index, through a US-domiciled ETF. This is a passive fund tracking the Nifty 50 index.
Tax Implications: Held in a tax-deferred IRA, allowing for tax benefits or tax deferral for US taxpayers.
End Corpus: The investment is held within the ETF structure domiciled in the US, and no taxes need to be paid until retirement due to the IRA.
In each case, we will consider
$1000 invested per year from Dec-2010 onwards once a year and redeemed now
USD/Rupee Exchange rates on the day of transfer used for cases 1 and 2
Investment in the Nifty US ETF considered with dividend reinvestment held in a non-taxable IRA (and not a taxable brokerage account)
32% state and federal tax bracket for the investor. 20% tax, total in India and the US, on selling the units in cases 1 and 2
USD/Rupee exchange rate plays an important role when you invest from the US into the Indian market. This chart shows you the performance of the US ETF (in USD terms with dividends reinvested), the Nifty 50 index fund (for a resident Indian investor), and the same Indian fund returns converted to USD. The massive outperformance of the Nifty 50 in Rupee terms disappears once you convert to USD.
The same trend is seen here for the annual performance figures of the Indian and US funds. Though the underlying stocks are different, the returns vary quite a bit.
Also read
How do you get from goal to SIP amount: Part 1
Yearly investment
IRR (flat SIP)
IRR (10% increasing SIP)
In Nifty 50 index fund (kept in India)
In Nifty 50 index fund (remitted)
In Nifty 50 US ETF (in US)
We are conscious that these are point-to-point returns but the analysis with rolling returns provides the same conclusion.
Related:
Understanding the 40% IRS Estate Tax: Crucial for Indians with US Assets
Invest in Indian stocks only if you are planning to come back to India
Of the three options explored here, the highest returns have come when the NRI has sent money to India, paid the taxes on the capital gains in the US and spent the money in India for some purpose. Alternatively, if the plan is to come back to India, then investing in Indian stocks makes sense.
Invest only in US-domiciled assets if the money is to be used in the US
Kolkata Investment
