What are the primary investment options for US-based NRIs interested in the Indian stock market?

The main investment options discussed are investing in an Indian Nifty 50 index fund without repatriation, with repatriation, or opting for a US-domiciled ETF tracking the Nifty 50.

What is a Passive Foreign Investment Company (PFIC), and how does it affect US-based NRIs?

A PFIC is a foreign corporation where a significant portion of its income is passive. For US-based NRIs, certain Indian investments fall under PFIC rules, leading to tax implications on notional gains, even if the assets are not sold.

What are the differences in returns when investing in the Indian stock market from the US vs. in India?

Returns vary based on the investment strategy. The article compares returns for $1000 yearly investments in Nifty 50 index funds in India, with and without repatriation, and in a US-based ETF tracking the same index. It highlights the impact of USD/Rupee exchange rates and tax brackets on these returns.

Which investment strategy yields the highest returns for US-based NRIs investing in Indian stocks?

The analysis suggests that higher returns typically occur when funds are sent to India, taxes on capital gains are paid in the US, and the money is spent in India or if there’s a plan to return to India. Alternatively, investing in US-domiciled assets is recommended if repatriation of funds to the US is intended.

Under what circumstances should a US-based NRI consider investing in Indian stocks?

Investing in Indian stocks may be suitable if there are plans to return to India or if the funds are intended to be spent in India. Conversely, opting for US-domiciled assets might be preferable if the funds will be used in the US and repatriation is necessary.

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Wall Street or Dalal Street: which is the best option for US NRIs to invest in Indian stocks based on PFIC rule?

Q: How are US-based NRIs taxed on their investments in India?

US tax residents, including citizens and residents, are subject to tax under PFIC rules on unrealized gains in certain Indian investments like mutual funds, ETFs, and AIFs. Direct stocks, real estate, and provident funds are not considered PFICs.

Posted on 29 Nov 2023
Author: Sayan Sircar

Tags: NRI

10 mins read
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The article compares various investment options for US-based NRIs intending to invest in the Indian stock market.

Wall Street or Dalal Street: which is the best option for US NRIs to invest in Indian stocks based on PFIC rule?

This article is a part of our detailed article series on the concept of PFIC taxation rule applicable to US NRIs. Ensure you have read the other parts here:

What should an US NRI do to become compliant with PFIC and FBAR rules on their Indian investments?

This article advises on the steps a US-based Non-Resident Indian (NRI) should take regarding unreported mutual funds in India under FBAR and PFIC rules.

Should US-based NRIs sell off their mutual funds and stocks in India?

This article makes US-based NRIs aware of the taxation on the unrealised gain rule if they invest in Indian stocks, ETFs and mutual funds.

📚 Topics covered:

How are US-based NRIs taxed on their investments in India
How much difference in returns will be there investing in the same stocks from the US vs in India?
Returns for a $1000 investment
What should an US-based NRI do to invest in Indian stocks?

How are US-based NRIs taxed on their investments in India

The IRS requires US tax residents to pay tax at their highest slab rate on investments in PFICs for every tax year (1st Jan to 31st Dec).

🛈 Who is a US tax resident?

Under the US Internal Revenue Code (Code), all US citizens and US residents are treated as US tax residents. For a non-U.S. citizen (alien individual) to be treated as a resident alien, they must satisfy either the green card test or the substantial presence test.

Source: OECD Website

Any NRI planning to stay in the US for some time will become a US tax resident after 183 days. The same rule applies to Green card holders as well.

🛈 What Is a Passive Foreign Investment Company (PFIC)?

A Passive foreign investment company (PFIC) is a foreign corporation for which either 75 percent or more of the gross income of the corporation for the taxable year is passive income, or the average percentage of assets held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.

Source: Cornell Law School

This tax is paid on unrealised gains. If your portfolio goes up by 10 lakhs a year, you pay 3 lakhs tax even if you did not sell anything

If we combine the above two definitions, any US-based NRI who is either a green-card holder or has stayed longer than 183 days in the US in a calendar year has to pay tax on Indian mutual funds, ETFs and AIFs (Cat 1 and Cat 3 only which do not have pass-through taxation). Direct stocks, real estate and provident fund (PPF/EPF) are not considered as a PFIC. This tax is paid on notional gains though you have not sold anything.

Warning: Taxes paid under PFIC are not refunded if you leave the US and come back to India. This rule will lead to severely lower returns on Indian mutual funds (and other PFIC eligible investments) in case you have paid the tax already.

A detailed primer on the concept of PFIC and related calculation is here: Should US-based NRIs sell off their mutual funds and stocks in India?.

This article will cover the return of investing in Indian stock market via two equivalent investments:

Dalal-street route: Indian Nifty 50 Index fund (Nifty MF in short)
Wall-street route: US-based ETF that invests in the Nifty 50 stocks in India (Nifty US ETF in short)

We will consider these cases:

Case 1: Investment in Nifty MF and the money is kept in India
Case 2: Investment in Nifty MF and the money is repatriated back to the US
Case 3: Investments in Nifty US ETF and the money is kept in the US

Case 1: Indian MF without repatriation

Investment Strategy: An investment approach where a US-based investor regularly invests funds in an Indian Nifty 50 index fund.

Tax Implications: Subject to PFIC rules, the investor pays tax on unrealised gains every year in the US at a combined (federal plus state) rate (assumed) of 32%. A 20% capital gains tax in India and the US under DTAA is paid on the final capital gains. If you have paid taxes in the US under PFIC, these will not be refunded in case you move back to India.

End Corpus: The invested funds remain in the Indian stock market and are not repatriated out of India.

Case 2: Indian MF with repatriation

Investment Strategy: An investment approach where a US-based investor regularly invests funds in an Indian Nifty 50 index fund.

Tax Implications: Subject to PFIC rules, the investor pays tax on unrealised gains every year in the US at a combined (federal plus state) rate of 32%. The final capital gains tax is 20%, just as the first option.

End Corpus: The invested funds are repatriated out of India at the end of the investment period.

Case 3: US-domiciled ETF (Exchange-Traded Fund)

Investment Strategy: Investment in the Indian stock market, specifically the stocks in the Nifty 50 index, through a US-domiciled ETF. This is a passive fund tracking the Nifty 50 index.

Tax Implications: Held in a tax-deferred IRA, allowing for tax benefits or tax deferral for US taxpayers.

End Corpus: The investment is held within the ETF structure domiciled in the US, and no taxes need to be paid until retirement due to the IRA.

In each case, we will consider

$1000 invested per year from Dec-2010 onwards once a year and redeemed now
USD/Rupee Exchange rates on the day of transfer used for cases 1 and 2
Investment in the Nifty US ETF considered with dividend reinvestment held in a non-taxable IRA (and not a taxable brokerage account)
32% state and federal tax bracket for the investor. 20% tax, total in India and the US, on selling the units in cases 1 and 2

How much difference in returns will be there investing in the same stocks from the US vs in India?

Nifty performance in Rupee and Dollar terms vs US Nifty 50 ETF

USD/Rupee exchange rate plays an important role when you invest from the US into the Indian market. This chart shows you the performance of the US ETF (in USD terms with dividends reinvested), the Nifty 50 index fund (for a resident Indian investor), and the same Indian fund returns converted to USD. The massive outperformance of the Nifty 50 in Rupee terms disappears once you convert to USD.

Annual returns for Nifty 50 TRI vs Nifty 50 US ETF is imapcted by the exchange rate

The same trend is seen here for the annual performance figures of the Indian and US funds. Though the underlying stocks are different, the returns vary quite a bit.

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Returns for a $1000 investment

Case	Yearly investment	IRR (flat SIP)	IRR (10% increasing SIP)
1	In Nifty 50 index fund (kept in India)	8.36%	8.45%
2	In Nifty 50 index fund (remitted)	4.37%	4.51%
3	In Nifty 50 US ETF (in US)	5.10%	5.03%

We are conscious that these are point-to-point returns but the analysis with rolling returns provides the same conclusion.

What should an US-based NRI do to invest in Indian stocks?

Invest in Indian stocks only if you are planning to come back to India

Of the three options explored here, the highest returns have come when the NRI has sent money to India, paid the taxes on the capital gains in the US and spent the money in India for some purpose. Alternatively, if the plan is to come back to India, then investing in Indian stocks makes sense.

Invest only in US-domiciled assets if the money is to be used in the US

The worst return has come in case that money, instead of being spent in India, is repatriated back to the US. If repatriation is needed, investing in the US-domiciled ETF is better.

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