r2i forum

Hello and Happy new Year!

I've been getting ready to start investing here in India. My plan was to just buy index-based mutual funds or similar, like I used to in US. However, over the past few days of researching on R2IForum, it appears that directly investing in MFs here leads to very onerous job of reporting for PFIC regulation, plus there is tax implications every year. In some posts, some senior members have suggesting building your own portfolio of individual stocks. Its not a desired strategy for me, I am not good at picking individual stocks and also don't have the right discipline to keep track of it, make adjustments etc.

I could not find much information about ETFs and its tax implication. there was one thread a few years ago where someone asked a similar question, but the discussion went off in another direction and the question was never answered ( I will link to that post when I find it again). Hence asking again - can an USC/OCI whose current status is ROR buy ETF based on the underlying mutual fund without having to deal with the PFIC reporting? I fear the answer is no, but thought to confirm.

I guess if answer is no, I will need to try my luck with individual stocks, since the consensus here seems to be to avoid MFs if you're investing from India.

Thanks!

Here is the post where the ETF question was asked before (it was comment #3), but looks it never got answered.

Deleted (to let someone more sure of the answer speak out)

Foreign based ETFs are indeed PFICs.

ETF's are getting popular in India as the Expense Ratio is very less (HDFC and ICICI Sensex and NIfty50 charges only 0.05% and 0.06%) which is a very good deal to track the exact Index. In India, most of the Mutual funds are 'Active-Based' and they claim that they beat the Index by 3% at an average. However, they also charge an expense ratio of 2.5% at an average and if we take the above ratio in consideration, the real net return is only 0.5% over Index. Maybe, 0.5% may play a big role if one hold for 10 years but given the intricacies involved in active funds, I personally like Index Mutual Funds better than Active Funds where I am ready to sacrifice 0.5% to 1% extra Alpha returns.

Now, the question comes whether to choose Index Mutual Funds or Index ETF's. The simple answer is Index ETF's as the expense ratio is very low compared to even Index Mutual Funds.

As far as Taxation in India is concerned, ETF's acts like Stocks and so are subjected to Short-Term Capital gains if one one holds the fund for less than 1 year. However when we hold ETF for more than 1 year which is Long-Term, then the Tax rate is '0' which is Tax-Free. The same above logic holds true for Index Mutual Funds as well as Active Mutual Funds too. To summarise, ETF's/Stocks/Mutual Funds (Index and Active) have same Tax Rate and hence there is no absolute difference in choosing any of the above vehicle.

Now comes, the big question of how USC/GC holders are taxed for investments based in India. The ETF's/Stocks/Mutual Funds are all subjected to PFIC treatment and hope Mr. Rajesh Dhurvaji and other senior will clearly explain the tax treatment of the above PFIC based investments as it will clear some of our members doubts.

LoveIndia;668950

Now comes, the big question of how USC/GC holders are taxed for investments based in India. The ETF's/Stocks/Mutual Funds are all subjected to PFIC treatment and hope Mr. Rajesh Dhurvaji and other senior will clearly explain the tax treatment of the above PFIC based investments as it will clear some of our members doubts.

The whole discussion of whether active Indian Funds are better than Indian index funds merits a seprate thread by itself, so I will skip that for the nonce.

About PFICs.

There are 3 ways of handling PFICs. One is very punitive, one is not really possible. The 3rd method is Mark to Market. It requires you to mark your MF holdings to market every year and pay taxes (at short term rates) on the difference. Although, this is the simplest method, it's still fairly cumbersome

You generally need to invest only in 'growth' MFs. I also think actually that Indian ETFs give out dividends too (i.e. there are not many pure dividend ETFs think dividends would be taxed at your regular rate (actually, technically I think dividends have to be handled by an extremely complex method for determining an excess distribution, but for simplicity's sake, you may just assume they are taxed at regular rates, not at qualified dividend rates).

MTM losses can be written off against income, but only against previous MTM gains for that PFIC. This requires a lot of book-keeping of gains for each PFIC, and updating each year.

Most US tax software (such as TT) does not handle form 8621s (for PFIC), so this form has to be filled in manually.

And there are FBAR and FATCA requirements as well.

Finally, Indian MF houses/brokerages need to allow you to buy these funds. I don't know if they will allow you once you attest that you are a US person. And if you have a brokerage account, you might as well buy individual stocks rather than ETFs.

And I should add that as far as I know, the new tax law does not impact PFICs at all, i.e. they are specifically excluded from all the changes to corporate taxation.

LoveIndia;668950ETF's are getting popular in India as the Expense Ratio is very less (HDFC and ICICI Sensex and NIfty50 charges only 0.05% and 0.06%) which is a very good deal to track the exact Index. In India, most of the Mutual funds are 'Active-Based' and they claim that they beat the Index by 3% at an average. However, they also charge an expense ratio of 2.5% at an average and if we take the above ratio in consideration, the real net return is only 0.5% over Index. Maybe, 0.5% may play a big role if one hold for 10 years but given the intricacies involved in active funds, I personally like Index Mutual Funds better than Active Funds where I am ready to sacrifice 0.5% to 1% extra Alpha returns.

Now, the question comes whether to choose Index Mutual Funds or Index ETF's. The simple answer is Index ETF's as the expense ratio is very low compared to even Index Mutual Funds.

As far as Taxation in India is concerned, ETF's acts like Stocks and so are subjected to Short-Term Capital gains if one one holds the fund for less than 1 year. However when we hold ETF for more than 1 year which is Long-Term, then the Tax rate is '0' which is Tax-Free. The same above logic holds true for Index Mutual Funds as well as Active Mutual Funds too. To summarise, ETF's/Stocks/Mutual Funds (Index and Active) have same Tax Rate and hence there is no absolute difference in choosing any of the above vehicle.

Now comes, the big question of how USC/GC holders are taxed for investments based in India. The ETF's/Stocks/Mutual Funds are all subjected to PFIC treatment and hope Mr. Rajesh Dhurvaji and other senior will clearly explain the tax treatment of the above PFIC based investments as it will clear some of our members doubts.

There is still a big challenge here. Try buying an Indian ETF in the market. The expense ratio is low and so on. The challenge is that liquidity of India ETFs is extremely. The size and volume of transactions of Indian Index ETF is nearly 10x to 20x is lower/smaller than its MF equivalent. So, buying and taking is very painful and cumbersome and you will also end up having to shell out higher than market price and wait a long time to sell if you invested a significant amount in ETF.

So, dig deep into it and experience it your self with small amounts before going all in to Indian ETFs

O.P. : I am in the same boat as you. OCI, now settled in Banaglore and looking for long term stable investments in India. For the sake of discussion, I am making some assumptions to understand things better...

1. Taxes covered under PFIC: If your invest Rs 1 cr, and the total interest of all investments (1st year at 8%) is Rs 8,00,000 which is equivalent to $12,272. Since that earning is in India and even after adding it, if your combined income (dual taxation exclusion under married filing jointly) is less than $195000 than you wont need to pay tax on it. Is that understanding correct ? If yes then for these assumptions PFIC shouldn't be an issue. right ?

2. Now the cumbersome declaration part. If you only distribute in few 4-5 funds and declare the earnings/loss every year ( whether you take distribution or not) than it should be doable. Right ?

3. Taxes IN India: Most of the long term investments have good tax incentives on interest income. Few have additional discount on maturity and In fact couple of them even EEE ( Tax deductions + Tax savings on interest + Tax saving on maturity). That is a very big plus imho

Having said that one should have a demat account for individual stocks for that portion of asset allocation where you can afford to be more adventurous. But I am not finding PFIC so restrictive as to write off the whole Mutual Fund/ ULIPS / ETF's investments in India which seems to be best bet for long term stable investments. Please let me know if I am missing anything.

Dwija123;671660O.P. : I am in the same boat as you. OCI, now settled in Banaglore and looking for long term stable investments in India. For the sake of discussion, I am making some assumptions to understand things better...

1. Taxes covered under PFIC: If your invest Rs 1 cr, and the total interest of all investments (1st year at 8%) is Rs 8,00,000 which is equivalent to $12,272. Since that earning is in India and even after adding it, if your combined income (dual taxation exclusion under married filing jointly) is less than $195000 than you wont need to pay tax on it. Is that understanding correct ? If yes then for these assumptions PFIC shouldn't be an issue. right ?

2. Now the cumbersome declaration part. If you only distribute in few 4-5 funds and declare the earnings/loss every year ( whether you take distribution or not) than it should be doable. Right ?

3. Taxes IN India: Most of the long term investments have good tax incentives on interest income. Few have additional discount on maturity and In fact couple of them even EEE ( Tax deductions + Tax savings on interest + Tax saving on maturity). That is a very big plus imho

Having said that one should have a demat account for individual stocks for that portion of asset allocation where you can afford to be more adventurous. But I am not finding PFIC so restrictive as to write off the whole Mutual Fund/ ULIPS / ETF's investments in India which seems to be best bet for long term stable investments. Please let me know if I am missing anything.

Interest does not fall under earned income category, it is passive income and does not qualify for earned income exclusion.

Point 2: Interst is not considered income fromPFICs.

Point 3. Funds do not give you interest.