Invest in what you know is the basic investing philosophy that is explained and followed by Peter Lynch, a very successful fund manager of the US fund company in his book - One up the wall street.
He basically explains that as an investor, find companies and businesses around you, from your every day to day life that you are familiar with (and then of course follow up on that with fundamental analysis). When we check the companies around us, we come across businesses like Microsoft, Google, Amazon, Sony, and hence, the desire to invest in foreign stocks begins. Furthermore. Higher returns, lower risks, better companies, and geographical diversification further increase the need to invest in foreign stocks
Where investing in foreign stocks is all fun and hopefully higher returns, one must also understand the setbacks or the costs of investing in the same.
1. Remittance charge
The costs of a remittance transaction include a fee charged by the agent/broker to you for their service of converting and remitting funds from Indian banks to US bank/broker accounts. It also includes FX conversion fee or spread for the purpose of investing in the US. This can range from 0.5-2% of the amount remitted and depends on two factors.
- Does the platform/app/broker you are using to invest have any tie-up with any of the Banks in India. For instance, Vested has a tie-up with the Bank of Mauritius, which helps as you pay only a 1.2% remittance charge for each side.
- If you are going to transfer directly and there is no special tie-up between the bank and broker, you can end up paying INR 1000 + GST (Fixed) to a minimum of 0.8 % of the transferred value as a remittance charge.
However, you can negotiate a better rate with your bank, depending on how much and how frequent your remittances will be. Even if you do at best, you can get a rate close to 0.8% of the transferred value.
Assuming you don’t make any gains from your investment and stay flat, you would incur approximately 2% in remittance charges. The bottom line, you end up losing a % of your funds to charges even before your investments start making money for you. Hence it is recommended that you transfer in and out in bulk rather than follow a SIP kind of approach to transferring money when investing in foreign stocks. This is especially applicable for smaller accounts.
2. Taxes collected at source (TCS)
The Union Budget 2020 introduced a tax on forex transactions. A 5% tax collected at source (TCS) will be applicable on all remittances above INR 7 lakh under RBI’s Liberalised Remittance Scheme (LRS).
TCS will apply only to over INR. 7 lakh in a fiscal year and not on the total amount. For instance, if you remit INR 10 lakh in a financial year, TCS will apply to the balance of 3 lakhs at a rate of 5% and thus will incur a tax of INR 15,000. The taxpayer will get a TCS certificate and can claim a refund while filing the annual IT returns. Thus, this is not a direct cost but gets added to your cash flows while investing the money.
You may not have to pay taxes on the earnings made from capital gains in the USA from US stocks but you would have to pay the same in India. For dividend tax is deducted at source in the USA but you do get credit for the same when you are paying taxes in India. Basically, it is good to know about the tax liability and compliances that you have to do when you invest in foreign stocks, you can learn more about it here in detail - How taxes work when buying US stocks from India
4. Death - Estate Tax
We Indians are not used to paying taxes on death and inheritance but in the US, Estate tax is payable by the heirs on the estate of a deceased individual, which can be as high as 55%. The estate tax can arise by way of investing in US assets. So your stocks and other capital market investments in the US are subject to estate tax when they are passed on as inheritance.This tax could end up eating into all the gains that one would make from investing in US stocks. Ways in which you can manage the estate taxes are as follows:
- Buy a separate (top-up) term insurance to cover this tax liability on your foreign stock investments.
- People set up joint accounts to deal with Estate taxes, so in the event of the death of one of the account holders, its estate tax is levied only on the portion of the asset held by the deceased.
- Now, if you are a UHNI (Chances are you would not be reading this, still) and looking at better ways of managing all of this, setting up an offshore trust to invest in the US seems to be the recommended route.
These charges and taxes are not a deterrent to your investments in foreign stocks but do know them and plan your investments around them.