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.
Phil Hodgen
Philip D. W. Hodgen is the principal attorney of HodgenLaw PC, an international tax law firm based in Pasadena, California. He earned his undergraduate degree from Claremont McKenna College and his law degree from the School of Law at the University of California, Los Angeles. He then went on to earn a Master of Laws degree with a specialty in taxation from the University of San Diego School of Law. Admitted to the California bar in 1982, Phil spent nine years in law firms and with a large U.S. bank before starting his own firm in 1991.
Phil is a past chair of the International Tax Committee of the State Bar of California's Tax Section and was a member of the Executive Committee of the State Bar of California's Tax Section for 2004-2007. Phil frequently speaks on a variety of international tax, trust and estate topics to attorneys, accountants, and real estate professionals.
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6 Comments
Even I have similar concern as Sandeep. I have a demat account (thru Indian financial institutions which is a trading account as well) for Indian stocks and I am in process of filling FBAR. My understanding was that demat is like trading account. Is that not true? And I had 1 more question, though I have not done this, but may be applicable in future, the question is under which section or form do we show the income from stock selling assuming it was a short term gain, and what is description for short term and long term gain from stocks traded in India stock market?
Since there is no other way of holding stocks in India, other than in a Demat account at a bank or brokerage, I think it is equivalent to what we call a brokerage account here in the US. I have not heard of a “brokerage account” in India. Also, shares cannot be bought or sold unless the holder gives instructions to either credit them or take them away from the Demat account and the balance in a Demat account is shown with current stock prices multiplied by the number of shares held. I would be interested in knowing if the IRS has considered a Demat account in India to be anything else than a brokerage account, which from what I have read, is to be reported on the FBAR.
A demat account is separate from your stock brokerage account. It is too complex to explain in a comment reply from a Blackberry 🙂 but think of the demat account as the box where you store your stock certificates virtually. You take stock out of the box to sell it
The virtue of demat accounts is that all stock is centrally registered so everyone — buyer, seller, and the company itself whose shares are sold — knows that the transaction is legit.
Isn’t a Demat account the same as a stock brokerage account, which is required to be reported on FBARs?
That was a good list Phil. Thnx. A lot of good points to consider for investments anywhere in the world, not just India.
A lot simpler — just buy ADRs of Indian stocks or an Indian index ETF from Blackrock. No fuss, no muss, no PFIC issues.
Comments are closed.
Tax laws change over time, and the information in this post above may be less accurate today than it was at the time of the last revision. This post is not tax advice for your specific situation. Please contact an international tax professional to get personalized advice for your situation.
Even I have similar concern as Sandeep. I have a demat account (thru Indian financial institutions which is a trading account as well) for Indian stocks and I am in process of filling FBAR. My understanding was that demat is like trading account. Is that not true? And I had 1 more question, though I have not done this, but may be applicable in future, the question is under which section or form do we show the income from stock selling assuming it was a short term gain, and what is description for short term and long term gain from stocks traded in India stock market?
Since there is no other way of holding stocks in India, other than in a Demat account at a bank or brokerage, I think it is equivalent to what we call a brokerage account here in the US. I have not heard of a “brokerage account” in India. Also, shares cannot be bought or sold unless the holder gives instructions to either credit them or take them away from the Demat account and the balance in a Demat account is shown with current stock prices multiplied by the number of shares held. I would be interested in knowing if the IRS has considered a Demat account in India to be anything else than a brokerage account, which from what I have read, is to be reported on the FBAR.
A demat account is separate from your stock brokerage account. It is too complex to explain in a comment reply from a Blackberry 🙂 but think of the demat account as the box where you store your stock certificates virtually. You take stock out of the box to sell it
The virtue of demat accounts is that all stock is centrally registered so everyone — buyer, seller, and the company itself whose shares are sold — knows that the transaction is legit.
Isn’t a Demat account the same as a stock brokerage account, which is required to be reported on FBARs?
That was a good list Phil. Thnx. A lot of good points to consider for investments anywhere in the world, not just India.
A lot simpler — just buy ADRs of Indian stocks or an Indian index ETF from Blackrock. No fuss, no muss, no PFIC issues.