Beware: Tax Complexity

Beware the taxation angle before you invest in "direct" foreign equity!

Warning: Long read!

This is not relevant for those who do not believe in tax compliance for ideological reasons or otherwise! 😉

Of late, I’ve seen a lot of interest & enthusiasm among Resident Indian investors to invest in foreign markets, esp. US markets, directly. LRS made this legally easier. There is also an emerging ecosystem of players (HDFC global investing, INDWealth, Vested,…) that is catering to this need.

This post does not get into the merits of foreign investments. Nor does it go into the legal aspects of cross-border transactions & investments. It also does not speak about the viability of the ecosystem. It merely tries to propose a thesis about the impact of a very narrow, operational aspect viz. tax compliance in India as far as Individual foreign investments are concerned.

(I will also not go into why the taxation system (in India or elsewhere) is how it is, whether it’s fair & just, how it has to be improved etc. There are alternative avenues for Resident Indians to take exposure to foreign equity, but that again is outside the scope of this post.)

Thesis: Anyone (Tax status: Resident Indian) wishing to dabble in foreign stocks should really not take the taxation angle casually and must take into account all the implications, procedures and paperwork and hassles involved. Don’t hold foreign stocks/ETFs/funds/other assets, unless you’re going to have substantial pay-off that justifies fees to an experienced CA.

Clarification: Please don’t misconstrue this post as a blanket rejection of direct foreign equity investments as an avenue. I just wanted to bring to the attention of investors this need for increased reporting compliance & paperwork as well as potential double taxation of dividends due to non-relief for Foreign Taxes Credit. This is an attempt to help you make a more informed choice by bringing to the fore an often overlooked factor and not to scare or dissuade everyone away from direct foreign equity..

Part A: Reporting of foreign assets and income

  1. You must fill out more detailed IT returnsYou cannot use Saral ITR form if you hold any foreign assets (even if those are acquired by default, such as via company stock awards or 401k when you were an NRI.) If you possess any foreign holdings, including bank accounts or stocks or real estate or just cash in foreign brokerage accounts, you are required to fill out FA & FSI schedules of ITR 2/ ITR 3 or others as applicable.

    1. This is true even if you have no other income to disclose, or even if your taxable income is below tax limit!

    2. Even if you have had no foreign transactions during the year and only passively held any foreign assets, you must fill up FA schedule.

  2. Disclose foreign income including dividendsYou have to fill out the FSI schedule to show transactions resulting in Income from Foreign Sources, and ensure that this income is also included in your total income computation.

    1. You have to include any capital gains (short-term or long-term) in CG schedule.

      1. This is applicable even if you don’t receive any proceeds in your Indian bank account and/or you let the gains stay with your broker as cash balance, or use it for another investment or deposit to overseas bank account

    2. You have to include the Foreign Dividend income in OS schedule under “Income from Other Sources – Dividends”

      1. This is applicable even if you hold stocks with automatic dividend reinvestment option, or even if you don’t actually receive the dividend in your Indian bank accounts and it stays with the broker as cash balance or you transfer it to your overseas bank account!

    3. You have to reconcile all your transactions to Indian financial year & accounting period (Apr 1 – March 31) and ensure that you do have all the statements to back up those transactions.

  3. While reporting your foreign holdings and transactions, you cannot use that day’s exchange rate as available from RBI or FBIL! There are some weird and arcane rules about how the foreign transactions are to be converted into INR. We have to use specific month-end rates from SBI!) This applies to purchase/sale transactions as well as dividends and tax withholdings / credits.

    1. SBI Telegraphic Transfer (TT) rates are available online, on their own website, for a given day. However, their historical rates are not readily available. IT Department demands that you use the previous month-end’s rates, and not the rates as per your actual transaction date. This means, you must carefully download and preserve all the month-end TT rates throughout the financial year.

Part B: Reporting of foreign taxes paid / withheld and claiming tax relief for the same.

  1. Report your tax relief claim: You need to fill out Form 67 that details the foreign transactions (dividends), US IRS withholdings etc. and also provide supporting documents (such as 1042-S from your broker, as well as any broker statements.) The form should ideally be submitted before you file your ITR for the given assessment year.

    1. This form can be filled out online (in the incometaxindiaefiling.gov.in portal after you log in) and can be submitted online along with proofs, since these past few years. You do get an acknowledgement with a reference number.

  2. Claim tax relief in ITR for any foreign taxes paid: You need to fill out schedule TR of ITR for any tax relief you are claiming. (In Excel utility, TR & FA are on the same page.)

    1. You can claim tax relief under section 90 or 90A or 91, depending upon whether DTAA exists with that country or not.

    2. In FA schedule, you have to also mention the article of DTAA under which tax relief is claimed.

    3. As an example: Looking at the case of US, where IRS withholdings are at the rate of 25%: Since OS gets added in your income computation and thus overall tax computation, and since TR gets included in your tax computation as a credit similar to Indian TDS, you would effectively be paying the 5% or so of difference to Indian ITD, or taking some money back if you are in lower than 25% tax brackets.)

      1. i. In case of US, you can claim TR under section 90, articles 10 & 25.

    4. All the steps above would ensure that your foreign assets are reported in ITR, your foreign income is included in your income computation and your withheld foreign taxes are accounted for in your tax computation.

Part C: In practice:

This is where the things get murkier.

  1. It seems that presently, there is little information exchange available between US IRS and Indian ITD, at least as far as small tax payers are concerned. Even if there is info exchange, maybe ITD pays only limited attention to entire set of data. Therefore, CPC is not in a position to validate the foreign taxes paid to IRS.

    1. This, even though you ensure that your foreign broker has your Indian PAN recorded with him and he mentions the same in 1042-S form. (1042-S is the US-equivalent of Form 16-A that we get in India from Banks as TDS statement.)

  2. As a result, CPC simply expresses its inability to process any ITR that has its TR schedule filled out and just transfers it to your Jurisdictional AO, who can happily sit on your ITR for years without processing it. (or sometimes, he processes the ITR without giving any Foreign Tax relief, which in turn may result in a tax demand.)

  3. In effect, you are never certain if rest of the sections of your ITR are in order, and you are not sure if you would really be given foreign tax credit, and you’re not sure when you will be issued any refunds due.

Part D: Repercussions of Non-compliance

Failure to report your foreign assets or income invites penal action under Black Money Act 2015.

  1. Undisclosed foreign income and asset will be taxed at a flat rate of 30 percent.

  2. Concealment of income and assets and evasion of tax in relation to foreign assets will be liable for prosecution with punishment of rigorous imprisonment up to 10 years

  3. Penalty for concealment of income and assets to be levied at 300 percent of the tax sought to be evaded

  4. Penalty of Rs. 10 lakhs may be levied on non-filing of tax return or filing of tax return with inadequate disclosure of foreign assets

and so on..

At the beginning of one’s career, one may be careless about tax compliance, however, one must remember the risks of a single transgression. Apart from being penalized for that one mistake for that one year, one exposes oneself to the risk of being in bad books of the taxman, who has full powers to reopen scrutiny / reassess any past years’ ITRs as well, which is a huge bureaucratic hassle to deal with and best avoided by small investors. (IT Department already acts on information from other tax jurisdictions and can cast its net as wide as it really intends.)

Bottom-line:

Even if you do understand and follow all the paperwork needed to claim credit for foreign taxes paid, it never guarantees that your ITR would be processed without manual intervention, (which otherwise has been a major accomplishment of ITD during this past decade. Most individual tax-payers have their ITRs processed via CPC and refund issued within a matter of weeks.) As you could see above, the paperwork itself is fairly tedious and time-consuming. And to top it up, not completing this paperwork, or not making all the disclosures about foreign assets is a high offense, punishable with stringent measures.

(Disclosure: I’m not a CA or certified tax professional.)

Written by: 4thinker (Published with permission)