How to calculate capital gains from U.S. stocks

Tax on gains made from selling shares on American stock exchanges differ from the taxation of capital gains made from selling shares listed on Indian stock exchanges.

RBI allows investment in foreign companies by regulating them through many routes like – Liberalised Remittance Scheme (LRS) under FEMA Act, Overseas Direct Investment (ODI), Income Tax Act 1961 compliances, etc. Investors investing in foreign stocks may have to comply with these regulations laid down by the Government of India.

Why should you invest in U.S. stocks?

Investment in the U.S. or any other foreign country stocks offers diversity and stability in returns to investors due to geographical diversification. Investing in global companies which are attractive and scalable can offer massive returns over the long term. If you have heard of FAANG (Facebook, Apple, Amazon, Netflix, and Google), investment in these tech giant companies a decade ago would have given you outstanding returns. Suppose someone invested $10,000 in the FAANG portfolio in 2012; their investment in 2020 would amount to $2,06,506 with around 1965% returns over eight years. Very few would have predicted these companies to have grown exponentially.

So if you are an avid investor, you should be diversifying your investments geographically. This piece will understand the tax implications on investments in the U.S. or any foreign country’s stock investment.

Taxability on various categories of individuals

On the tax front, the Income Tax Act has laid down residency rules that determine the residential status of the taxpayer. 
Firstly, let’s determine the residential status of the taxpayer to understand the tax implication on the gains from foreign investments. The Income Tax Act has laid down three categories of residential status of individuals, namely: 

1. Resident and ordinarily resident (ROR) – For residents, global income is taxable in India.
2. Resident not ordinarily resident (RNOR) – Taxability arises only when foreign income is received in India or accrued in India from a business or profession controlled or set up in India.
3. Non-resident Indian (NRI) – Taxability same as RNOR.

The residential status mentioned above is to be derived based on the number of days of an individual’s presence in India during the relevant year and previous years as per the rules laid down in the Income Tax Act.
To know more about the residency rules, click here.

The primary sources of income from foreign investments can be dividend income, capital gains from foreign stocks or capital gains from U.S. mutual funds.

Let us see the tax implications on U.S equity investments.

Capital gains on foreign stocks

The capital gain would arise on U.S. stocks when they are sold at a price higher than the purchase price. The good news is that if the investment is sold at a profit, there will be no tax implication in the U.S. on this gain.

However, as the tax resident of India, you have to abide by the tax laws of the country, and hence the following will be the implications :

• Long-term capital gain
• Short-term capital gain

Any gains arising on stocks not listed in India shall be treated similarly as unlisted shares. Accordingly, the gains will be treated as long-term or short-term depending on the holding period of investment.

Long-term capital gains on U.S stocks

If the shares are held for more than 24 months before selling, it will be considered a long-term capital gain.

Long-term capital gain from the sale of foreign stocks (not listed on the Indian exchange) will be leviable at the flat rate of 20% plus health and education cess (plus surcharge, if applicable). Also, the indexation benefit will be available at the cost of the investment.

Short-term capital gain on U.S stocks

If the shares are held for less than 24 months before selling, it will be considered as short-term capital gains. 
Whereas short-term capital gain from the sale of foreign shares will be added to total income and taxable at the individual’s slab rate.

Double Tax Avoidance Agreement

The Indian Government has entered into the Double Tax Avoidance Agreement (DTAA) with more than 95 counties, which helps claim the tax credit in case of double taxation.
DTAA usually offers relief by two methods (i) Exemption method (ii) Tax credit method. 
The exemption method taxes the income in one country and exempts it in the other. In contrast, the tax credit method allows the taxpayer to take the credit of the tax paid in one country from the tax liability arising in another country.

According to DTAA between India and the USA, both of the countries may tax capital gains as per the applicable domestic law with an exception to shipping and air transport companies. In other words, generally, capital gains are subject to tax based on the country’s domestic laws.

For example, if a resident Indian earns long-term capital gain income from the U.S. stocks, then as per U.S. tax laws, they are liable to pay a maximum tax of 15%. However, net capital gain tax is nil if taxable income is less than $80,000. According to the Indian Income Tax Act, 1961, the resident individual is liable to pay long-term capital gains at the rate of 10% on amounts exceeding Rs.1 lakh. Suppose the gains become taxable in India’s home country, the USA government will give credit for the tax paid in India.

ITR filing compliance in case of U.S. investments

• It should also be noted that if you have invested in foreign stocks or hold a financial interest in an offshore entity, you will have to mandatorily file a tax return in India, even if your income is below the basic exemption limit taxable in India.
• The disclosure of details like a list of foreign assets, bank account, income earned from foreign investments, foreign taxes paid and tax credit claimed under respective DTAA, etc., is to be provided to the income tax department.
• Individuals can file ITR-2 or ITR-3 based on the nature of income earned.

Read More:

• How to file ITR if you invest in US stocks?
• What is DTAA?
• DTAA between India and USA