anand on September 17th, 2008

The recent events in the US financial markets have led to a sharp downturn in India’s markets too. Additionally, with the dollar strengthening against the rupee, the purchase power of the dollar has gone up significantly over the past three-four weeks. These two events, individually but more so coupled together, make considering investments in India very attractive.

Investments in the Indian stock markets has some great advantages. I am often surprised that expats, NRIs and others do not always realize some of the subtle advantages. Beyond being a hot growth area for the past few years (30-40% returns have been the common for a lot of mutual funds), the subtle advantages are on the tax treatment for these invesments. In this note, I’m just focusing on this tax treatment.

Coming from the US, the biggest advantage in India is the capital gains tax (or the absence of this). There is no long term capital gains on stocks or equity mutual funds (i.e. having average holding in equity above 65%). In essence, if you hold stocks for more than one year, there is no capital gains. Take a moment, think about this… Investing in Indian equities is like having a Roth IRA account without any investment limits.

Additionally, dividends from these companies (or MF) are tax free.

Ok, time to close that open jaw.

The capital gains on debt instruments or debt funds held over a year are taxed at 10%. However, you can actually get taxed less on some of these investments with something called indexation (the way I understand this is that your cost price is increased by a factor somewhat related to the inflation). This implies that your taxable effective gains are lower than the difference between sale and purchase prices. If you factor indexation, then you pay 20% on the gains – however, depending on when you purchase (and sell) in relation to the tax year (Apr-Mar), you can apply indexation twice (I believe). In the recent past, due to the high indexation and applying it twice, this 20% effectively is much less than the flat 10% (you have a choice to apply whichever formula you wish when calculating your taxes).

Looks pretty good, right? Add to this the current interest rates on liquid mutual funds (cash equivalents that pay dividend) to be approx 9% after tax, we’re beating the pants off the 3% return you are getting on the money sitting in a US bank CD.

Do you have more ideas or thoughts regarding this? Drop me a comment.

Note: while my concepts are right, the details may not be. Do research and revalidate any information I provide in case you plan to act on it. Do not treat this as investment advice and certainly not tax advice.

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4 Responses to “Investments in India”

  1. Hey Anand,

    You make a very good point and even if you want to play it safe, sticking money into a savings account NRE/NRI/whatever is still a better investment than the 3% you would get here. Although, being an investor type, the lack of capital gains makes it so much more appetizing to invest in Indian markets!

    Shalin
    PS-moneyvidya.com will be specifically to help investors find the stocks to invest in for the Indian market!

  2. Shalin,

    Yes, you’re right. It seems like a no-brainer to put money earning 11% interest by transfering dollars at today’s rates (USD $1=~INR 45). There are better bond funds, money market funds and closed end bond funds (called FMPs) that are even more tax efficient (giving approx 9% after tax).

    Plus, recent market downturns could be used as a buying opportunity though further falls are likely given the global financial scenario.

    Thanks for your comments!

  3. Anand,

    How can an NRI living in US take advantage of these tax benefits. Are these applicable only to resident Indians or NRIs as well? What are the tax implications that NRIs need to be aware of before investing in stocks and mutual funds in India?

  4. Mahipal,

    Thanks for your comment!

    Here is my broad understanding of taxation for NRIs. Income earned by NRIs outside India is not taxed in India. Income (e.g. salary) earned within India maybe taxable. However, specifically, the following Indian earned income may not be taxable

    interest from deposits in NRE or FCNR accounts (for those who don’t know, these are a special class of accounts for NRIs).
    dividends paid by Indian companies
    no long term capital gains for stocks and equity mutual funds

    The information as per government of India is available at this Overseas Diaspora page.

    In short, it seems that the same advantages (if not more) from a taxation perspective is available to NRIs.

    I’d also add that (as per my understanding), NRIs can also open regular accounts – the advantage of repartiation of dollars or other currency from NRE accounts is dimished or diminishing, whereas, in some instances, the flexibility of the accounts may be marginally more for regular accounts.

    You may also want to read essential documentation you would need to open accounts is India.

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