Hold US stocks under LRS? Here’s why you may not be able to gift them to NRI children

Indian law bars gifting US or any foreign stocks bought under the RBI’s liberalised remittance scheme (LRS) to NRI individuals including their NRI children. Para 22(4) of the Master direction on overseas investment expressly prohibits any Indian resident to transfer their overseas investments to an NRI.

Mayank Arora, associate partner, Nangia Global, said to ET Wealth Online that the important point to note here is that the LRS requires sale proceeds of assets to be repatriated within a timeline of 180 days. The provision, thus, restricts in-direct outflow of funds.

What else does FEMA law say about US stock investing?

While there are no dedicated provisions for investment in the US, investment by individuals in foreign markets are governed by the LRS and the Overseas Investment Framework, and in this regard, Arora says a few points have to be noted. These are:

• Investment classification: Stock holdings below 10% of a listed company are considered Overseas Portfolio Investment (OPI); on the other hand, stock holding of 10% or more in a listed company, or any stake in an unlisted company, is Overseas Direct Investment (ODI), with significantly heavier compliance requirements.
• Repatriation mandate: Dividends and sale proceeds must be repatriated to India within 180 days of receipt, or reinvested abroad. Retaining funds offshore without reinvesting is non-compliant.
• Regulatory filings: Form A2 must be submitted to the authorised dealer bank for every outward remittance, with the correct purpose code. Annual Performance Report has to be submitted by the ODI investors with the RBI by 31 December each year.

Also read: Employee wrongly declared Rs 14 lakh Australian salary in Indian ITR: ITAT grants tax relief but denies Rs 3.4 lakh foreign tax credit

Can sale proceeds of US stocks bought though LRS, fund a child's US investor visa, education, or other expenses?

Arora says that the liberalised remittance scheme specifically provides for repatriation/ reinvestment of funds once realised. Usually, we do not classify consumption expenditure as 'reinvestment'.

Arora says: "Accordingly, realised funds should not be used for such expense utilisation."

Also read: On ESOP value over US$ 60,000 US estate tax up to 40% can be levied after death of even a non-US resident; Here’s how to manage its impact on legal heirs

How does US estate tax affect US stocks purchased through LRS if the Indian resident investor dies?

Arora says that if an Indian resident investor buys US stocks under the Liberalised Remittance Scheme (LRS), such holdings may become subject to U.S. federal estate tax upon the investor's death.

Arora says that under the U.S. law, shares of U.S. companies are treated as "U.S.-situs assets" and, in the case of a non-resident non-citizen (such as an Indian resident individual), only a limited exemption of USD 60,000 is generally available.

Arora says: "Accordingly, where the value of U.S. securities held by the deceased exceeds USD 60,000, U.S. estate tax may apply on the excess value at progressive rates, potentially up to 40%."

Since India does not presently have an estate tax treaty with the United States, Indian residents can't avail any higher treaty-based exemptions.

In practical terms, Arora says that on the investor's death, the U.S. broker may freeze the account until the legal heirs or executor comply with applicable U.S. estate tax filing and clearance requirements, including filing IRS Form 706-NA and obtaining a transfer certificate from the IRS.

Also read: Rs 17.41 lakh penalty for ITR filing mistake: CA firm's owner's affidavit helps taxpayer get relief in ITAT Mumbai; know how

What can Indian residents do to reduce US estate tax exposure on LRS-purchased US stocks?

Arora says that US tax exposure may be minimised by eliminating direct ownership of U.S.-situs securities by investing through non-US-domiciled investment vehicles.

Arora says: "One such vehicle is Irish-domiciled ETFs that track U.S. markets, since the investor holds units of a non-U.S. fund rather than shares of a U.S. corporation directly, such holdings are generally not treated as U.S.-situs assets and therefore substantially reduce exposure to U.S. estate tax."

In addition, Arora says that many families also undertake lifetime gifting and succession planning strategies including transferring holdings to children while they are still Indian residents to remove the assets from the taxable estate at an early stage and avoid subsequent FEMA complications associated with gifting to NRIs.

How to report such US stock investments in Indian ITR?

If you have purchased US stocks directly, then in India, you have to report this in ITR-2 along with schedules that have to be filed (or ITR-3 if business income exists). ITR-1 and ITR-4 cannot be used by anyone holding foreign assets.

Arora says that the investment has to be declared by way of following schedules:

• Schedule FA (Foreign Assets) has to be filed for declaring all the US stock holdings and foreign brokerage accounts in Schedule FA if, even if no income was earned. This schedule is reported on the basis of the calendar year (Jan-Dec), and not the Indian financial year.
• Schedule CG (Capital Gains) has to be filed to report gains or losses from sale of US stocks in Schedule CG after converting values into INR.
• Schedule FSI (Foreign Source Income) has to be filed to declare foreign income such as US dividends, interest, or capital gains in Schedule FSI. This schedule follows the normal Indian financial year (Apr-Mar).
• Schedule TR & Form 67 (Foreign Tax Credit) has to be filed if US taxes were deducted on dividends or other income, claim relief through Schedule TR. Form 67 must also be filed to claim foreign tax credit in India.
• US stock dividends should additionally be reported under "Income from Other Sources."