Thinking of investing in overseas stocks? Get your tax math right

By Rajeshree Sabnavis & Darshini Shah

Indian investors and financial consultants are increasing talking of diversifying investments globally to mitigate the risk of uncertainties in domestic market. Indian investors have the option of investing in overseas markets through a variety of instruments, such as American Depository Receipts, Global Depository Receipts (GDR), exchange-traded funds, overseas-focused mutual funds, direct investing in foreign stocks and employee share-based plan (ESBP), among others.

Today, multinational companies are eager to internationally engage employees. However, for many organizations a major concern is hiring and retaining the best talent and cash flow constraints. ESBP has emerged an attractive tool to retain and motivate the best employees.

Employee stock options plan (ESOP) is the most common among the various ESBPs. Some other plans such as restricted stock units (RSUs), employee stock purchase plan (ESPP) and stock appreciating rights have also gained popularity over the years, especially in cross-border option schemes. A cross-border stock options plan enable allows parent companies registered outside India to enable Indian resident employees to participate in their global stock options plan.

In direct stock investing, an Indian resident individual can acquire foreign stocks directly under the liberalised remittance scheme or under the ESBP. These stocks can yield income to individuals in the form of price appreciation on sale and as dividends.

In the words of Franklin D Roosevelt: "Taxes are paid in the sweat of every man who labours." Hence, it is imperative for one to understand the tax mechanism and obligations when diversifying an investment overseas.

Typically, there are various stages in a stock options plan. They include grant, vesting, exercise and sale. In India, for stock options plan, there is two-point taxation; the first is when the shares are exercised and other at the time of sale of such shares. Further, taxes are levied depending on the residential status of a person. For instance, where the individual qualifies as a resident and ordinarily resident (ROR), his global income is taxed in India.

At the first point of tax, in the case of ESOP, the difference between Fair Market Value (FMV) of shares on the exercise date and exercise price is taxed as perquisite in the hands of ROR under the head ‘income from salaries’.

In the case of RSUs, the first point of tax incidence arises at the time of vesting. Here, the FMV of shares shall be considered as on the date of vesting of shares. In the case of ESPP, the incidence of tax arises at the time of purchase and perquisite value is difference between the discounted price and the FMV of the shares on the date of purchase.

This perquisite value is added to the salary of the employee. Consequentially, the employers are required to deduct tax at source on it.

In the case of foreign shares, employees have to pay cash enough to cover the perquisite tax liability. Companies may permit one to opt for sell-to-cover option, wherein employers withhold and sell shares overseas enough to cover the perquisite tax lability and subsequently deposit net shares in the employee’s account.

In case of a non-resident (NR) or resident but not ordinarily resident (RNOR), income that accrues/is received or deemed to accrue/ to be received in India is taxable in India. If such NR or RNOR employees are rendering services in India on the date of allotment of shares, the benefit arising as perquisite should be preferably taxed in India proportionately, basis the number of days present in India during the grant and vesting period.

Now, when an investor sells foreign shares, the resultant gains are taxed on difference between full value of consideration and cost of acquisition (COA) under the head ‘capital gains’. Shares held for 24 months or more are considered as long-term capital assets and capital gains arising are taxed at 20 per cent with indexation of COA.

In case where shares held for less than 24 months are considered as short-term capital assets and the gains arising on sale of such shares are taxed at applicable slab rates. Individuals can avail exemptions on capital gains earned by re-investing capital gains / sale proceeds in specified assets subject to specific conditions.

The second point of tax on options plan arises on sale of shares. The period of holding of shares is considered from the date of allotment of shares. While calculating gains, COA is the FMV which had been considered at the time determining the perquisite value.

At times listed Indian companies engaged in specific knowledge-based industry or subsidiary company of such company’s issue GDR in foreign currency to its Indian resident employees in accordance with the notified ESOP scheme. Long-term capital gains and dividend arising are taxed at concessional rate 10% after fulfilling specific conditions.

Additionally, investors earn dividend income from foreign stock holdings. From financial year 2020-21, dividend earned from domestic as well as foreign companies are taxable in the hands of investors. Hence, dividend earned from foreign shares by ROR will also be taxed at applicable slab rates under the head ‘income from other sources’.

The taxation of income of capital gains and dividend shall also be subject to the benefits available under the applicable double taxation avoidance agreements, where individuals can avail beneficial rate of tax or foreign tax credit, where there is a double taxation. The ultimate tax liability arising on capital gains and dividend can be discharged by paying advance tax or self-assessment tax at the option of the taxpayer.

Further, it is also worthwhile to note that the individuals are required to report details of foreign assets held in foreign asset reporting schedule at the time of filing the tax returns in India.

Thus, while evaluating investment plan in foreign stocks, one must not only determine merits based on income and capital appreciation potential or fluctuation of foreign exchange rates, but also consider after-tax yield from such an investment.

(Rajeshree Sabnavis is Founder and Darshini Shah is a Consultant at boutique tax consultancy firm Rajeshree Sabnavis & Associates. Views are their own.)