Tax on overseas investment and capital gains

Authored by Amit Gupta, MD, SAG Infotech

Many people choose to invest their money in overseas markets as a way to give it global exposure and increase their returns and reduce risk through diversification. However, one should be aware of the tax rules on overseas investment and tax on capital gains from the money invested in foreign markets when looking to diversify their portfolio across geographies.

Tax rules for overseas investment

Though residents in India are allowed to remit up to $2,50,000 per year in the overseas market, they should do it only after due diligence to ensure good returns on their investment. The returns from overseas investments are taxable, so one should consider tax too when planning to invest in foreign equities.

Tax rates on capital gains made from equity shares/companies listed abroad are different from tax rates on domestic (Indian) equities. Apart from the gains made from selling equities, tax is also payable on dividends and rental income from overseas.

Here’s a closer look into the tax bearing on different asset classes overseas, including equity, real estate investment trusts, and the sale of physical properties.

Tax on overseas equities

Direct investment in shares listed in foreign stock exchanges and mutual fund investments in overseas assets fall into this category. Income from both sources is taxable in India and should be reported by residents when filing their annual tax returns.

Tax on long-term capital gains (two years or more) from the sale of foreign equity shares is 20 percent, plus cess and surcharge. The gains made from the short-term sale (less than two years) of foreign equities are taxable at the slab rates of the individual.

As for mutual funds having overseas shares, the threshold for considering an investment long-term is three years, the same as debt funds in India and the returns are taxed at a 20% rate after indexation. Short-term capital gains (less than three years) are taxed at the slab rate. The indexation benefit due to the change in price from foreign to Indian currency is also applicable.

Dividend income earned from foreign equity shares and mutual funds is taxable at the slab rate.

Tax on overseas debt

There are also some overseas fixed-income or debt instruments that Indian residents can invest in and earn interest and capital gains. These include debt mutual fund schemes that invest in overseas markets and stocks.

Tax on foreign debt mutual fund gains is the same as the tax on domestic debt funds. Long-term capital gains (three years or more) from foreign debt funds are subject to a 20 percent tax, with indexation. Short-term gains are taxable at the slab rate.

Tax on Foreign Real Estate & REITs

If you have invested in real estate in a foreign market either directly (purchase-sale of physical properties) or through REITs, here’s how your gains will be taxed:

Long-term capital gains (two years and more) from the sale of foreign real estate are taxed at a 20% rate after indexation, while short-term gains (less than two years) are taxed at the slab rate. Any rental income from foreign real estate will also be taxed at the slab rate.

If you have invested in foreign REITs, you can make an income through dividends, interest, rental, and long and short-term capital gains. Any dividend, rental, and interest income made from foreign REITs will be taxed at the slab rate of the individual. Long-term gains (two years or more) from the sale of foreign REITs are taxed at 20%, while any short-term capital gains will be taxed at the slab rate.

When looking to invest in foreign real estate or REIT, one should also know about available tax benefits and rebates. For one, rental income earned from foreign real estate is not eligible for a 30 percent rebate that you can claim on the rental income earned from a property in India. Also, the tax deduction benefits (up to Rs 1.5 lakh on principal and up to Rs 2 lakh on interest) are also not available for loans taken for a property outside India.

Property owners in India can also save tax by using the proceeds from the sale of a residential property to buy another house within a year. This benefit is not available if the proceeds are used to buy property outside India.

Reporting foreign investments in your income tax return

Any overseas investments, including equity, debt, and real estate, must be reported in your annual tax returns, either in ITR-2 or ITR-4. If you are already paying tax abroad on your investments, make sure to fill out the prescribed form 67 to claim a credit for taxes paid overseas.