Why Indian HNI’s prefer ODI route to invest in international real estate

In recent times affluent Indians have sought to diversify their investment portfolio beyond Indian shores by investing in International Real Estate (IRE). Allocating funds to international markets is seen as a strategic approach to effectively reduce risks and optimize profits. The presence of foreign investments (particularly in IRE) contributes to mitigating the adverse effects of domestic inflation and volatility in currency exchange rates, while also serving as a means to hedge against currency risk.

Many countries have, inter alia, based their long-term visa, residency and work permit programs on receiving foreign investment, and one such example is the United Arab Emirates’ (UAE) Golden Visa Scheme thereby making it lucrative for individuals to make investments, especially, for those looking to diversify and explore employment and business opportunities abroad.

Family offices, private wealth management firms for High-Net-Worth individuals (HNIs), have also been active in purchasing property abroad to increase the “global assets” of affluent Indians.

The Liberalized Remittance Scheme (LRS) allows resident individuals to remit up to $250,000 per financial year for various capital account transactions, including investments in real estate abroad. However, this amount is seldom adequate for the large amount of investment that resident Indian HNIs seek to make in IRE.

Furthermore, under the LRS, clubbing of remittances among family members is permissible. Thus, a family of four can club and remit up to $1 Million per FY and up to USD 2 million, in two FYs, in the manner discussed above; provided that all such family members are co-owners of such investment, or, the said amount is being remitted to an overseas bank account in which all such family members are joint account holders. Thus, depending on the investment required to acquire the IRE and inter-se arrangement on co-ownership, this option is generally adopted.

The constraint posed by the aforesaid monetary limits in a financial year per resident individual is typically, overcome by investing at the end of March in one financial year (FY) and then again in April of the next FY, thereby, allowing investments of up to $500,000 to be made in one month.

Another workaround, that allows for increased investment in IRE is through the Overseas Direct Investment (ODI) route wherein individuals or family offices set up a Limited Liability Partnership (LLP) or a company in India, which in turn sets up or invests in another overseas entity (foreign entity) to undertake “bonafide business activities”, overseas.

Such foreign entity then as an ancillary measure acquires the identified IRE to carry out its “bonafide business activities”. The Foreign Exchange Management (Overseas Investment) Rules, 2022 (“OI Rules”), define “bonafide business activity” as follows: “shall mean any business activity permissible under any law in force in India and the host country or host jurisdiction, as the case may be”.

The benefits of adopting the ODI structure/route are twofold. Firstly, under OI Rules, Indian LLP’s or companies are allowed to invest up to 4 times their net worth and the limit of USD 250,000 stipulated under the LRS is not applicable in this scenario.

Secondly, resident individuals making capital investments under the LRS are subject to 20% Tax Collected at Source (“TCS”) for remittances above Rs. 7 lakh in a year; however, Indian entities – LLP’s and companies, are not subject to such TCS.

Given the aforesaid TCS obligation places an additional financial burden on resident Indian HNIs who are desirous of acquiring IRE, the ODI route which results in a tax-efficient corporate structure is preferred. Unfortunately, during the adoption of such structures and often due to lack of legal advice, the purpose of the OI Rules and regulations and their emphasis on encouraging “bonafide business activities” gets defeated.

The Reserve Bank of India (RBI) has taken cognizance of this trend and its impact on the existing Overseas Investment (OI) framework. India’s OI framework, presently, does not permit ODI to be undertaken in foreign entities engaged in “real estate activity”.

The RBI appears to have taken a view that the objective of the foreign entity undertaking “bonafide business activity” under the OI Rules, gets defeated in some instances where foreign entities set up to acquire “IRE” under the Indian entity investment structure do not undertake any “bonafide business activity”.

Indian tax residents are subject to tax in India on their global income irrespective of the country of source of such income. An individual is considered as a tax resident of India if he is in India for 182 days or more in that year (subject to some exceptions).
It is important to note that an Indian citizen staying abroad is also deemed to be a resident in India if, his total income from Indian sources exceeds INR 15 lakhs during the relevant year and he is not liable to tax in any other country because of his domicile or residence or any other criteria of similar nature. This would impact the residential status of Indian individuals residing in zero-tax jurisdictions like UAE.

Generally, in India, rental income from letting out IRE is taxable as income from house property whereas gains from the transfer of such property is taxable as ‘capital gains’ (subject to relevant rules). The taxability of such income should also be examined under the provisions of the domestic laws of the relevant countries read along with their tax treaties with India.

Individuals should claim a credit for the foreign taxes paid by them and also disclose details of IRE held by them in their tax returns.

Thus seen, from a resident Indian HNI’s perspective, legal advice must be obtained, before adopting the ODI route for making investments in IRE and also from an Indian income tax perspective. Any blanket amendment(s) of the OI Rules and regulations by the Government of India and RBI, to address the aforesaid concerns, may result in over-regulation and “bonafide business activity” being hampered.

(Authors are Vivek Chandy, Joint Managing Partner, JSA Advocates & Solicitors and Kumarmanglam Vijay, Head of Direct Tax and Partner, JSA Advocates & Solicitors.)