November 15, 2011 - Phil Hodgen

US tax and the Indian stock market

An article in The Hindu Business Line notes that the it may soon be possible for foreign individuals to invest directly in the Indian stock market. Whether this is a good idea from an investment perspective (or not), I leave to your good judgment.

However, from a U.S. tax point of view, this is a room full of mirrors for a U.S. individual, pension fund, or trust.  If you are thinking of investing in Indian stocks, please remember your friends at the IRS.  Any investment gains you make will be incinerated by IRS penalties if you screw up paperwork.

  • Do not buy Indian mutual funds.  These are PFICs (“Passive Foreign Investment Companies”) and they create a metric ton of complexity and accounting expense for your U.S. income tax returns.  (This, by the way, is one of the U.S. government’s little non-tariff trade barriers, designed to discourage U.S. capital being deployed into foreign capital markets).
  • Remember your FBAR.  The account you open that will buy the stock will need to be reported on Form TD F 90-22.1.
  • Demat account.  Super-secret bonus points for the truly aware — you may end up with an account at a stock brokerage and a demat account as well.  Even though the demat account is really just the electronic equivalent of a stock certificate (and thus should not be a reportable item for Form TD F 90-22.1) in fact I believe the IRS will have a different perspective.  The IRS thinks everything is reportable and wants to know the name of your poodle.
  • Remember Form 8938.  This is the new reporting form for foreign financial assets, largely duplicating the FBAR reporting requirements.
  • Foreign tax credit.  The article does not describe the Indian tax regime that will apply to foreign investors.  Undoubtedly a tax of some kind will be imposed. This will end up on an individual return on Form 1116.  Make sure you understand how this works so you get the maximum possible credit in the USA for taxes paid in India.
  • What if you die? Be sure you have a plan for simple transfer of your accounts to your heirs if you die.  The cost of probate procedures in India will evaporate any stock market profits you make.  Bonus points:  if you set up a trust in India to handle the transfer on death problem, you now have a foreign trust, according to the IRS.  Form 3520, Form 3520-A.

“What’s your point, Phil?”  The point — plan ahead for your IRS paperwork so you don’t make a lot of money in India and then pay it over to the United States Treasury.

Americans Living Abroad