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TCS, LRS, and Foreign Tax Credit: Tax laws and limitations to be aware of before investing overseas

The continuous degradation of the Indian Rupee versus the US Dollar is one of the important concerns that an Indian Investor must consider while investing in US-listed stocks. Although this may attract more Indian investors looking to make Overseas Direct Investments in the US due to greater returns in terms of the Indian Rupee, investors looking to make short-term Overseas Portfolio Investments may be wary of investing in such an environment.

Apart from rupee depreciation, an investor should consider several other factors before investing in US-listed security, such as country and economic risks, risk of liquidation and diversification, and so on.

Maximum Permissible Foreign Investment

The Central Government, in collaboration with the Reserve Bank of India (RBI), released Overseas Investment Rules, Regulations, and Master Directions around the end of August 2022, which govern overseas investments undertaken by Indian residents. Under the Liberalized Remittance Scheme, an Indian Resident is entitled to make Overseas Investments in foreign stocks/bonds up to US Dollars 250,000 every fiscal year (roughly 2 crore rupees) (LRS). The aforementioned restriction also applies to investments made by an investor in Gift City IFSC.

It should also be noted that without the express permission of the Reserve Bank, Indian investors are prohibited from investing in foreign entities engaged in real estate activity, gambling in any form, or dealing with financial products linked to the Indian rupee.

In India, there is an obligation to collect tax at the source.

According to Section 206C(1G) of the IT Act, every authorized dealer bank is required to levy and collect tax at source (TCS) at 5% where an Indian investor makes foreign investment in stocks under LRS and the amount of remittance exceeds Rs. 7 lakhs in a fiscal year. If the Indian investor does not have a PAN or Aadhaar, TCS will be collected at a higher rate of 10%.

As with other TDS/TCS regulations, such tax deducted/collected can be recovered as a credit by the investor when completing their Indian tax returns. However, the investor may take such TCS sum into account when grossing up their investment remittances.

Foreign Tax Credit Advantage

According to the laws listed above, investors will be required to pay tax in India on income or gains obtained from international investments. Such persons may be subject to taxation in the United States at the headline individual capital gains tax rate. This might result in double taxes for the investment.

To prevent double taxation and stimulate cross-border investment, India and the United States signed a Double Taxation Avoidance Agreement (DTAA), which allows Indian investors to claim tax credits for taxes paid in the United States. However, such a deduction cannot exceed the Indian tax paid on earned US income.

Furthermore, to claim a foreign tax credit, investors must file Form No. 67 on the e-filing platform on or before the end of the assessment year in which the return of income for such assessment year was filed within the period required in Section 139(1) or Section 139(2). (4).

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