Foreign stocks are the stocks of the company situated outside the global boundaries of India. After globalization, retail investors are now interested in diversifying their portfolios to minimize the risk and at the same time increase profits. Therefore, foreign stock investment seems to be a very attractive option for this.
In this blog, we shall discuss some basics of foreign stock investment, the ways of investing in foreign stocks, and the risks associated with it. Furthermore, we shall discuss foreign stock investment from the point of view of taxation, which is, the amount received every year in the form of dividend/interest. Also, tax on gain or loss associated when the stock is sold.
Table of Contents
Basics of foreign stock investment
Financial advisors generally suggest investing up to 5% to 10% of the total portfolio in foreign stock investment for conservative investors and up to 20 to 25% for the aggressive investors. This not only allows the investor to minimize their risk by diversification but also increases their profits.
Modes of investment
After liberalization, privatization, and globalization, the boundaries of the nation are not limited, as investors get the opportunity to diversify their portfolios by investing in foreign stocks. There are various ways through which foreign stock investment has become way easier. Following are a few modes:
1. American Depositary Receipts
Commonly known as ADRs, it is a certificate issued by the US bank which you can trade in the US stock market. It represents shares in foreign stock. It is priced in US dollars. Just like US stocks, ADRs are also listed, traded, and settled and hence are a convenient method for foreign stock investment. They can be sponsored and unsponsored and come in level one, level two, and level three. It is a very convenient way to raise capital from the market. For example, Alibaba in 2014 raised $25 billion by issuing ADRs.
2. Global Depository Receipts
In this, the overseas depository bank issues shares of a domestic company in the form of a certificate or receipt to the residents of the overseas country. For example, an Indian company wants to get its shares listed on the German Stock Exchange. It can do so with the help of the GDR by agreeing with a German depository bank. After compliance with the laws of both countries, the German depository bank shall issue a certificate to German residents. In simple language, a domestic company issues shares to the residents of the foreign country. It is generally denominated in US dollars.
3. Foreign direct investment
It can be done in two ways:
i) Global account in the home country
ii) Local account in the target company
However, foreign direct investment is advisable only to active investors who frequently deal in such cases. Otherwise, it is a very expensive source of investment and also involves a high risk of fraud.
4. Indirect international exposure
For investors who do not want to indulge in various formalities associated with foreign direct investment but wish to have international exposure can opt for such schemes as investing in multinational companies or investing in global mutual funds. The crux is to invest in the companies that derive their revenue from foreign countries.
Risks associated with foreign direct investment
- Currency fluctuation risk – It is a very well-known fact that prices of the currencies keep on fluctuating. Therefore, it involves currency fluctuation risk. However, investors sometimes gain and sometimes lose money with such fluctuation in exchange rates.
- Risk of fraud – In investing globally, many times brokers involved in the process turn out to be a fraud and retail investors may suffer loss because of it.
- Volatility risk – It represents how did the asset’s price swings towards its mean price. Higher the volatility, the riskier the stock.
- Political risk – It is associated with the fluctuation in the stock price due to the political disturbance in the country. Since this risk can never be foreseen, an investor may suffer a loss.
Foreign direct investment – income tax point of view
Taxability comes into the picture in two cases
- Interest/dividend/share of profit is received.
- Capital gain/loss arising at the time when the stock is sold.
To determine the taxability of foreign stock, we need to first understand the concept of a person’s residential status in India, i.e., ordinary resident, non-ordinary resident, and non-resident. It is determined based on the number of days stayed in India.
|Residential Status of India||Income taxable in India|
|Ordinary Resident (OR)||Global income taxable in India|
|Not Ordinary Resident (NOR)||Incomes which are received in India, deemed to be received in India, accrue or arise in India, deemed to accrue or arise in India are taxable in India|
|Non Resident Indian (NRI)||Incomes which are received in India, deemed to be received in India, accrue or arise in India, deemed to accrue or arise in India are taxable in India|
Based on the residential status of the assessee, it is to be determined whether the income is taxable in India or not.
1. Income from dividend
Dividend received as a share of profits every year is taxable at normal slab rates like other income in India. Therefore it is to be added to the total income of India. Also as per DTAA between India & the US, the dividend is to be taxed at a flat rate of 25%. Therefore, US companies while paying dividends withhold 25% of the amount and pays only a balance of 75%. However, to avoid double taxation, the assessee can claim credit of the tax withheld by the foreign company and paying only the balance amount of tax. For instance, an ordinary resident earns a dividend of $500 from a US company. Then that company shall withhold $125 and shall pay the balance of $375 only. However, while paying tax in India, the assessee shall add $500 to his total income but he can also claim the credit of $125.
2. Capital gain
If the period of holding of the asset exceeds 24 months, then it shall lead to long term capital gain which shall be taxed at the rate of 20% + cess + surcharge, if any. Furthermore, indexation benefits shall also be available. If a period of holding is less than 24 months then short-term capital gain shall be added to the total income and taxed at normal slab rates.
Investments in foreign stocks come with various benefits and at the same time various risks. Further, it involves a lot of procedural formalities. However, it is an attractive source of investment option. Also, it is advised to seek professional opinion wherever necessary.
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