If you are intending to invest in a foreign stock, this article is for you to understand the implications under the provisions of the Foreign Exchange Management Act (FEMA) and the Income-tax Act.
The FEMA prohibits the investment outside India beyond a certain limit. Under the Liberalised Remittance Scheme (LRS), resident individuals can invest abroad by way of acquisition and holding shares of both listed and unlisted overseas company and debt instruments.
The limit of overseas direct investment by the resident individual shall be within the overall limit prescribed under the provisions of the Liberalised Remittance Scheme, by the RBI. Currently, Liberalised Remittance Scheme has prescribed a blanket Limit of USD 2,50,000 for certain specified purposes only. If you invest in foreign stocks, you earn Capital Gains and Dividend Income. The tax treatment of both such incomes under the Income-tax Act and treaties has been explained here:
The income taxable under the head capital gains depends upon various factors such as the period of holding, cost of acquisition, the full value of consideration, etc. Shares of a foreign company shall be treated as short-term capital asset if they are held for not more than 24 months immediately preceding the date of transfer. In other cases, it shall be treated as long term capital gains. However, if such shares are listed on any Indian stock exchange, i.e., the stock exchange located in International Financial Services Centre (IFSC), then such period shall be 12 months instead of 24 months.
The tax treatment of the capital gains arising from the transfer of shares listed on a foreign stock exchange shall be similar to the capital gains from the unlisted shares. Long-term capital gains arising from the sale of unlisted equity shares shall be taxable at the rate of 20% plus surcharge and health & education cess. The benefit of Indexation would be available to the resident taxpayers. In the case of non-residents, the tax shall be charged at the rate of 10% without providing for the benefit of indexation and foreign currency fluctuation.
However, if the foreign stocks are listed on any stock exchange in an IFSC, the long term capital arising from the sale of such listed shares over ₹1 lakh shall be taxable at the rate 10% plus surcharge and health & education cess. The benefit of indexation and foreign currency fluctuation shall not be available in this case. The short-term capital gain arising from the transfer of unlisted shares shall be taxable at the normal rate of tax. Whereas, the short-term capital gains arising from the transfer of shares listed on any stock exchange in an IFSC shall be taxable at the rate of 15%.
India has entered into DTAAs with more than 95 countries. The treaties allocate the taxing rights between the source country and the resident country. Almost all the treaties contain the provisions that the capital gains arising from the alienation of shares of a company shall be taxable in the source country. Thus, the capital gains arising to a person resident of India from the transfer of foreign shares shall be taxable both in the foreign country (on basis of source rule) and in India (on basis of residence rule). However, the foreign tax credit can be claimed in the country of residence for the taxes paid in the source state.
Tax Treatment of Dividend
Dividend received by a resident shareholder in respect of the foreign shares shall be taxable in India at the applicable tax rates. The dividend is taxable on a net basis after claiming a deduction of interest expenditure incurred to earn that income. The deduction for the interest expenditure shall not exceed 20% of the total dividend income. No further deduction shall be allowed under Section 57 for any other expenses including commission or remuneration paid to a banker or any other person to realise such dividend.
However, where total income of an Indian company includes any income by way of dividends declared, distributed or paid by a foreign company, in which such Indian company holds 26% or more in nominal value of the equity share capital, the dividend shall be taxable at the rate of 15% subject to the condition that no expenditure shall be allowed to be deducted from such income.
As per the DTAAs, the dividend is taxed in the country of the source according to local tax laws. However, if certain given conditions are fulfilled, the dividend shall be taxable in the source state at a concessional rate. As per most of the DTAAs entered into by India, the dividend is taxable in the source country in the hands of the beneficial owner of shares at the rate ranging from 5% to 15% of the gross amount of the dividends.
Claim of Foreign Tax Credit
If the income from foreign shares is taxable in both the countries (resident country and the source country) and the assessee has paid tax in the source country, he shall be allowed a credit for the same in the country of residence, by way of deduction or otherwise. The credit shall be allowed in the year in which assessee offered such income to tax or assessed to tax in India. A taxpayer is required to furnish a statement in Form No. 67 on or before the due date for furnishing return of income to claim the foreign tax credit.
Disclosure in ITR
Details of income by way of dividend need to be entered in Schedule OS, Income from other sources, in case income is taxable at normal tax rates and in Schedule SI, Income chargeable to tax at special rates, if such income is taxable at special rates.
Details of income by way of capital gains need to be furnished in Schedule CG, Capital Gains, depending on its nature (Short term or long term). Further information is required to be furnished in Schedule SI, Income chargeable to tax at special rates, in case such income is taxable at special rates.