Under the present overseas investment regime an Indian resident can make an overseas investment overseas under the Liberalized Remittance Scheme (‘LRS’), wherein investment upto USD 2,50,000 can be made in overseas listed and unlisted companies or under the Overseas Direct Investments (ODI) regime where investments can be made through an Indian company in overseas entities as equity investments, loans or guarantees depending on the business needs of the foreign investee entity. Equity shares can also be acquired under a private arrangement or from the market through stock exchanges.
If the investor remits more than INR 7 lakhs in a financial year under LRS then a tax of 20% is collected at source (‘TCS’). The TCS is collected by the authorized dealer bank and remitted to the Government on behalf of the payer. The amount of TCS can be claimed as a credit by the remitter against his tax liability for the relevant financial year.
An increase in TCS to 20% of the amount remitted has however reduced the attractiveness of the LRS for investors as it significantly increases the amounts required for making the remittance and requires blocking 20% of the amount invested in a low interest-bearing avenue (assuming that additional TCS paid is refunded with interest of 6% by tax authorities after returns are filed). It also limits a person’s ability to make remittances for other permitted uses such as supporting family for education, health etc.
Investments made under ODI regime by a company do not attract TCS and allow the Indian company to redeploy the funds received without necessarily distributing to the shareholders who are taxed at a much higher rate than a company. Therefore, investments via ODI route are considered better for making long-term investments by High-Net-worth Individuals.
While making ODI investments, an important aspect to be considered is the applicability of the ‘place of effective management’ (‘POEM’) rules under the tax laws. This is critical because if a foreign company has its POEM in India, then it will be regarded as a tax resident of India and taxed in India accordingly.
With effect from April 1, 2023, the preferential tax rate of 15% on dividends received from a foreign company is withdrawn in a case where the Indian company held at least 26% equity share capital. Accordingly, the dividends received from such foreign companies are now taxable in the hands of the recipient as per applicable tax slabs.
However, where the Indian company receives dividends from a foreign company but distributes dividends to its shareholders as well, it is entitled to a deduction to the extent of lowering the amount of dividend received from the other company or dividend distributed by it.
An Indian investor can also make overseas investments in an International Financial Service Centre (‘IFSC’) in India by making a contribution to an investment fund or vehicle set up in IFSC as an ODI / OPI (‘Overseas Portfolio Investment’), subject to conditions.
Where an investment is made in a unit located in IFSC, then several tax benefits may be available to the unit located in the IFSC but the same will need to be analyzed depending on the business carried out by the unit.
Any investment made outside India and the income therefrom is required to be disclosed by the resident investor in Schedule ‘Foreign Assets’ of the Indian tax return. Failure to report or misreport foreign assets/ income can result in imposition of penalty and prosecution risks under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act (‘BMA’) that came into effect from April 1, 2016.
In a recent decision, Mumbai Bench of the Income Tax Appellate Tribunal upheld the levy of penalty under BMA for non-disclosure of the foreign asset in the return of income despite the taxpayer explaining the source and paying income tax.
Additionally, one must carefully consider the compliance obligations under the local laws of the jurisdiction where the investment is made in order to remain compliant with such laws and avoid penalties, etc.
All in all, while LRS may offer ease of investment to individuals, owing to recent changes in tax laws ODI route may still be preferred by the HNI’s who can deal with the interplay of multiple laws in both jurisdictions and tread carefully to protect and grow their investments.
[Author is Kumarmanglam Vijay Partner and Head of Direct tax at JSA and Divyam Mittal, Senior Associate at JSA]