Investment in US Stocks – Changes in Taxation – Read this before you Invest!

Indian investor thinks about buying international stocks, one of the first concerns on his mind is the tax on selling foreign shares in India.

After the release of numerous fintech applications like IND Money and others, investing in foreign stocks is now simple. But is the buzz justified?

To start, let’s explain where we can invest. According to RBI policy, an Indian citizen may send up to 2.5L USD abroad. Simply put, a resident of India may invest up to 2.5L USD. Therefore, investing is possible in stocks from any nation. There isn’t a restriction per se, but almost all fintech platforms offer a way to invest in US stocks. Let’s now examine the benefits and drawbacks of investing in US markets.

Advantages –

Investing in Global leaders –

Global giants like Amazon, Google, Facebook, Microsoft are listed in US. And ofcourse, any prudent investor wants to invest in them.

Diversification–

There is a saying that “Don’t put all your eggs in one basket”. Diversification helps in reducing the risk of volatility. As  Diversification across various sectors is recommended, the same applies to diversification across countries.

Exchange Rate Gain –

Historically, the value of the Indian rupee relative to the dollar has declined. One might anticipate the same to occur in the upcoming years taking into account a number of elements. Consequently, your investment will increase as the value of the dollar does.On the flip side ,one has to bear High charges, taxes etc

Disadvantage –

High charges –

Investment in US Stock comes with a hefty cost. Despite the fact that the investing intermediary insists there are no transaction costs. They charge withdrawal fees, which are present. For example, Vested charges $5 per withdrawal, while INDmoney charges $5 per withdrawal for withdrawals under $2,000 only. INDmoney provides no withdrawal fees for withdrawals over $2,000 per transaction.

Taxation –

Taxes – As long as Indian equities are held for longer than a year, capital gains up to a total of 1 lakh rupees on sale are not subject to tax. However, US stocks are not eligible for this benefit.

a) Long-Term Capital Gains Tax Rate

The gain from selling the stock will be subject to India’s Long Term Capital Gains rate if you have held the stock for longer than 24 months. The rate on long-term capital gains is 20%. (plus any additional surcharge and cess fee).

b) Short-term capital gain tax rate

If you sell the stock before 24 months, it will be considered as ordinary income, and the tax rate will be applicable depending on your tax bracket

Note: There is no tax due in the US on the selling of US stocks.

Dividend taxation is governed by a tax treaty between the US and India. As a result, an Indian’s tax liability on any dividend received is a fixed rate of 25%. This tax rate is significantly lower than that of any other foreign investor who makes investments in the US.

You will get 75% of the dividend amount after deductions, with the tax withheld at the source. However, you will be relieved to know that the US and India have a double taxation avoidance agreement. Due to this arrangement, you won’t have to pay double taxes (both in the US and India).

Given that you already paid 25 percent tax in the US, you will receive a foreign tax credit of 25 percent and must pay taxes in India that are higher than the 25 percent rate.

Budget 2023 Amendment – Increase in TCS to 20% from 5%

An increase in the Tax Collection at Source (TCS) rate for international transfers was suggested in the Union Budget 2023. The TCS for fund transfers made through the Liberalized Remittance Scheme (LRS) has increased from 5 percent to 20 percent.

Let’s first define TCS in order to fully understand the implications of the above for foreign investments.What is TCS? 

Tax Collection at Source (TCS) is a system of indirect taxation introduced by the Indian government. TCS refers to the collection of tax on certain specified goods or services at the time of transaction. The seller collects a certain percentage of the sale value as TCS and deposits it with the government.

TCS on remittances was initially introduced in the Union Budget 2020. In this previous regulation, 5% TCS was applied once LRS transactions crossed INR 7 Lakh or when the source of funds was an education loan. 

What are the new TCS rates?

How does this impact US investors?

From 1st July 2023, Authorised Dealers (typically banks and remittance companies) will collect 20% TCS for remittances made for international investments. For example, if you invest INR 10 Lakh in a calendar year, 20%, or INR 2 Lakh, will be deducted as TCS.

Previously, the cap was set at 7 lakhs, and TCS’s rate was only 5 percent. Therefore, despite the fact that this provision already exists, due to the high limit, ordinary investors are unaware of it.

Can we claim credit for the 20% TCS?

Yes! The tax paid should not be confused as an additional cost or tax on the fund transfer.The TCS paid can be claimed as a credit against tax payable when filing income tax returns. If the TCS is higher than your tax payable, you will receive a refund. 

Let’s look at a quick example: a resident Indian individual wants to invest INR 1 Lakh in US equities. According to the TCS rules, a tax of 20% will be applied, which means a TCS of INR 20,000 would be collected and deposited with the government.

If the individual’s tax liability is INR 50,000 at the end of the year, he will only be liable to pay the difference, INR 30,000. Alternatively, if his tax liability is INR 10,000, he will receive a refund of INR 20,000. 

Investors will suffer greatly as a result of the government’s decision as 20% of their funds gets blocked irrespective of any monetary limit. Has that money been invested in the stocks for the year, they would have earned more. Let us take an example of an Individual investing 1 lakh in US Stocks. Only 80k would be invested in stocks and the balance amount would be deducted as TCS. If the person has earned a return of 12%. Gain in absolute terms would be 9600 (12% * 80,000). Considering the return in relative terms gives us a return of 8.5% (net of charges) which is way below the actual expected gain. As a result, we anticipate a decline in investment in foreign stocks in the coming years.

Tip – Hence, if you’re planning to invest in Foreign Stocks for FY 24, it is better to invest before July to avoid blockage of funds.

As we understand the benefits/ shortcomings of investing in US Stocks, now let us understand the historical returns –

Historical returns of NFTY & NASDAQ –

Over the last decade, Nasdaq -100 delivered a TRI (total return index) of 31.2% CAGR, while the S&P500 and Nifty 50 posted a TRI of 23.3% and 13.6% in the same period.

NIFTY 50 –

NASDAQ –

Historical performance cannot guarantee future results. But historical performance aids us in making the optimal investment decision. A CAGR over 10% is a reasonable investment return. Can we claim that US Markers have reached a saturation point given the enormous growth in prior years. To comprehend this, we must assess the Market Cap to GDP Ratio (Warren Buffets tool).

The Market Cap to GDP Ratio, or Buffett Indicator, is a calculation that compares the value of all publicly listed equities in a nation to its Gross Domestic Product (GDP).  It is used as a broad way of assessing whether the country’s stock market is overvalued or undervalued.

Market cap to GDP Ratio – Market cap of public entities/ GDP

 India –

India’s ratio is 112%, whereas the US’s is 156%. The perfect ratio is under 100%. Anything over 100 is overvalued, and anything under 100 is overvalued. Indian markets were below 100% before to COVID, but are now close to 100%. If we only take the indicator above into account, we can conclude that the US market is overvalued.

Having established that a ratio below 100% is favourable for investment, let’s examine several nations where this ratio is below 100%.

China  – 78%

Germany – 45%

In terms of value criteria, India triumphs!

It appears that the Indian market is undervalued when we compare it to other global markets. However, as geographic diversification is advised, it is wise to invest 10-15% of your portfolio in multinational corporations like Amazon, Google, and others since they have operations around the world and are too big to fail.They have been working in a variety of fields recently to develop innovative solutions. You may join this innovation journey by funding such US businesses.

Before we end this article, let us give a snip of PE Ratio of FAANG (Top US Stocks) for quick reference –

*AMZN reported loss for the Quarter 1 of 2023. Hence PE is 0. Erstwhile PE is around 80.

We will cover each of the above stock in our US Stock Series. Stay tuned!!