Migrating to the US has been a dream for many. But when Karen was moving to the US with her husband and children, there were many considerations that needed discussion, including her residential status, bank accounts, tax and investment considerations, domestic investments and how she would need to update her know your customer, or KYC, status and report all investments made in India to the Internal Revenue Service (IRS) in the US. Karen had investments in mutual funds and some Ulip (unit linked insurance plan) policies in India.
When a US citizen owns funds overseas, the tax compliance could be quite dizzying. Unlike in India, US authorities tax individuals based on their residency and tax status. Therefore, the US will tax its residents and citizens on income earned from investments in the US and investments overseas.
A resident of India holding a green card would need to pay tax on income earned in India and on the global income earned in the US while filing tax returns in that country.
However,when you are paying taxes in both the countries, the DTAA (double tax avoidance agreement) treaty between India and the US comes into play and one is required to pay taxes only on the difference between the taxes in the two countries.
A US citizen must fill form 8621 at the time of filing US tax returns. This is required when the Declaration of Foreign Assets exceeds $10,000 in a particular calendar year. In addition, Form 8938 needs to be filled, which is a statement of foreign financial assets, akin to the Report of Foreign Bank and Financial Accounts (FBAR) with more detailed declarations.
A foreign mutual fund where underlying assets are managed by a trustee (mutual fund here) on behalf of an investor is referred to as a Passive Foreign Investment Company (PFIC). Therefore, for Karen, her investments in Indian mutual funds and Ulip policies will fall under the PFIC guidelines. This makes it complicated for her as she now needs to report in addition to her earnings in the US, her income from investments in India, and both capital gains and dividend income. The reporting compliance includes filling the form FBAR and Form 8621 and the reporting compliance could be in either of the below two methods:
One is the market to market (MTM) or excess distribution method. Let’s say Karen holds a mutual fund with an investment value of $100,000 and the year-end value is $150,000. Even though Karen does not sell her mutual funds at the end of the calendar year, she is subject to capital gains on unrealized gains. The difference between the purchase cost and the current value is the unrealized gains which will be taxed as per US capital gains tax rates.
The second is the Qualified Electing Fund: If Karen doesn’t utilize the MTM method every year and, say, purchased the mutual funds in 2019, and the value of the funds was $250,000 in 2024, in which case Karen now has to pay gains on all the previous years using the phantom method assuming she has made gains every year for the years it was held by her.
Not reporting one’s holdings in either manner can lead to penalties that are severe in terms of penal codes, passport revocation, and heavy tax outgo. The considerations change for families who live partly in India and partly in the US. Typically, the young children migrate to the US for favourable work and living opportunities and the parents stay back in India. This could involve cross border taxation, and investment considerations, including trust creation.
How much should be invested in India and overseas? This question comes up quite often among our investors and while diversification asset allocation is an important consideration, what the client wants and where she plans to settle eventually drives the financial planning process.
So, what should Karen do when she has become a green card holder? Among some options, she could invest in Indian equities through US-based ETFs or invest in Indian portfolio management service (PMS) whereby the underlying shares belong to the investor, and she does not fall under PFIC compliance issues and therefore her tax and compliance burden reduces drastically. For Ulip policies issued after 1 February 2021, in case the aggregate premium in a financial year exceeds ₹2.5 lakh, the maturity proceeds from such policies would be taxed as capital gain on the basis of the recent Finance Bill. However, the tax exemption under Section 10(10D) of the Act would continue for policies with annual premium less than ₹2.5 lakh in aggregate subject to provisions stated therein. The same provisions would be applicable for NRIs who have purchased a Ulip.
(Karen’s example is hypothetical.)
Dilshad Billimoria is managing director and principal officer, Dilzer Consultants Pvt Ltd
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Updated: 18 Jul 2023, 10:17 PM IST