The taxation of foreign shares considers factors such as the date of acquisition of shares, the purchase and sale prices as well as the period of holding of shares.
Investment in foreign stocks (shares/securities) by an individual is a good way to diversify investments and earn better returns. Though the basic investment process while investing abroad is similar, there are key aspects to be considered.
Acquisition of foreign stocks by individuals could be either by way of direct investment or through purchase. Under the Liberalised Remittance Scheme (LRS), all resident individuals are allowed to freely remit up to USD 2,50,000 per financial year, subject to applicable conditions. In addition to the LRS, individuals can also invest under the Overseas Direct Investment (ODI) route, both of which are regulated by RBI
Individuals could also acquire foreign stocks by way of participation in regulatory compliant Employee Stock Ownership Plan (ESOP) of the employer.
Taxation of income from foreign stocks
The taxation of foreign shares considers factors such as the date of acquisition of shares, the purchase and sale prices as well as the period of holding of shares. This would help individuals understand the tax rates applicable on the income.
Foreign shares held by an individual for more than 24 months are treated as long-term capital assets and others are treated as short-term capital assets. Capital gain from sale of long-term capital assets would be taxed at 20% with the indexation benefit on purchase price or at 10% without such indexation benefit. Indexation is applied to adjust for inflation over the period of holding the asset. Capital gains from sale of short-term capital assets would be taxed at the slab rates applicable for the individual.
For individuals qualifying as a Resident and Ordinarily Resident (ROR) in India, the income is taxable in India. However, in case of a Non-resident (NR) or Resident but Not Ordinarily Resident (RNOR), income earned and received outside India is generally not taxable.
There are some reliefs provided under Indian tax laws in case capital gains are reinvested in prescribed schemes/assets. Overall, taxation of capital gains is a wider concept and needs deeper analysis.
Shares purchased under an ESOP
In case of ESOP shares, the taxation happens at two stages: at the time of allotment of shares and on sale of shares. Under the typical stages of ESOP i.e. grant, vest and exercise, taxation triggers at the time of allotment of shares. The income is determined based on the difference of the fair market value (FMV) of shares on the date of allotment and the amount paid to acquire such shares. This income is treated as perquisite and taxed as part of salary income at the applicable slab rates.
The second tax trigger for ESOP shares would be at the time of sale of shares wherein the income would be the difference between the sale proceeds and the cost of acquisition of shares (i.e. FMV). The individual would need to pay tax on such capital gain.
There are other key considerations in case of taxation of ESOP shares:
- Tax residency of individual at the time of allotment of shares
- Tax residency of individual during the vesting period i.e. grant to vest dates
- Cost of acquisition to be considered
- Challenges in claiming double-taxation relief/foreign tax credit under a Tax Treaty owing to the differentiation in nature of income from ESOP i.e. as employment income or capital gain
Dividend income earned from foreign stocks is taxed under the head ‘Income from Other Sources’. In case of certain ESOPs, an individual may also receive dividend-equivalent income on unvested shares. These are generally taxed as part of salary income. However, it is advisable to have a thoughtful reading of the features of ESOP to determine one’s taxation.
Some of the Tax Treaties may provide lower tax rates on capital gains and dividend income. A careful study of the facts of each case in view of the Tax Treaty could enable individuals to claim the benefits under the relevant Tax Treaty.
Mode of payment of tax
Tax on salary income in case of ESOP shares is subject to tax withholding by employer. For capital gain on foreign shares (either acquired directly by individual or under an ESOP), the tax needs to be discharged by the individual himself by way of Advance Tax or Self-assessment Tax.
The Indian Income Tax Return (ITR) forms are revamped each year to bring more simplification and transparency in terms of reporting income and assets holding. In case of capital gain income during FY 2019-20, the individual would need to file Form ITR-2 or ITR-3.
The reporting would be as below for foreign stocks:
- Schedule CG for Capital gain
- Schedule OS for Dividend income
- Schedule FSI and Schedule TR for claiming foreign tax credit in case of double taxation relief
- Schedule FA: Details of holding of foreign shares/securities
Considering the nuances for foreign stocks, a clear insight of the taxation laws is essential for individuals for their taxation purposes.