Mutual funds, AIFs etc. are not tax-efficient solutions for the USA and Canada-based NRIs. There are more straightforward options to address this issue.
The global economic environment is challenging, and the respite is not any time soon. High inflation is expected to stay in the western world, and it will keep interest rates elevated for some time. So much so that the USA is dealing with inflation that they last experienced these elevated inflation levels a few decades back. Globally, the future growth prospects do not look bright.
On the other hand, India managed its monetary policies better than a lot of western countries. Although RBIs current inflation target is 4% (with a 2% threshold), the average inflation over the last 20 years has been around 7% p.a. The latest data indicates 6.5% as India’s inflation rate. India’s primary concern about inflation is the oil price. Given that the global economy might be under low growth headwinds, India stands strong.
As per the world bank report, India is expected to be the highest-growing economy in 2023 and 2024. A young population, China +1, Production linked incentives, and India’s payment stack are some of the areas that can help India double its GDP in the next 5-7 years.
It’s not a surprise that NRIs want to invest in their home country. Indian tax laws and security laws are pro-foreign and NRI investors. Like most of the major countries in the world, India has a bilateral tax treaty in place. This means double taxation can be avoided for investors. Recently, SEBI has made KYC norms more stringent for NRIs so that money laundering issues can be avoided. Irrespective, there is a massive inflow of funds to India to capture the expected growth.
In India, NRIs and Residents are treated at par. However, local tax laws can wary. In India, a simple way to invest is by using mutual funds. The process of mutual fund investments for a US / Canada-based NRI is as easy as for resident Indians.
However, the local laws (USA IRS and Canadian tax laws) are not tax efficient for mutual fund investments. If you are an Indian living in the USA, it is most likely that you have come across the term PFIC. PFIC is an acronym used for Passive Foreign Investment companies.
Simply put, if you are invested in an Indian Mutual Fund, you must declare the investment and income in the US. If you are a joint income tax filler in the US, you are exempted up to Rs 50 lakhs ($25,000 each). However, if you are invested more than Rs 50 lakhs (Rs 25 lakhs singly), you are not just required to report to IRS but also pay taxes on the unrealised gains.
Indian tax laws do not differentiate but must follow FATCA rules and report to the US counterparts. Even if you don’t report to IRS, still the information is shared with the US authorities. A few mutual funds offer investments to US-based NRIs but beyond $25k, it does not make sense for US investors to allocate to Indian mutual funds. Similar laws prevail in Canada too.
One way to address this issue is to hold investments directly and not in a fund structure. This way you don’t have to pay taxes on the unrealised gains.
Additionally, Alternative Investment Funds (AIFs) fall in the same category as PFIC, making AIFs also not a good investment vehicle for US-based NRI investors. Another, investment option is investing in India using Portfolio Management Scheme. Investment using PMS is tax efficient both in India and in the USA. Interestingly, there are not many PMS accepting money from US/Canada-based NRIs.
Disclaimers
Investment in securities market are subject to market risks. Read all the related documents carefully before investing.
The securities quoted are for illustration only and are not recommendatory.
Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.
Details of the advisor
Advisor: Ankur Kapur
SEBI RIA No.: INA100001406
BASL Member ID: BASL1337