Tax and conversion charges when investing in American stocks

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Before you go ahead and invest your hard-earned money into the American stock market, it is essential to first know all of the various charges and taxes that you would have to incur for the same. This is simply because of the fact that such expenses can significantly impact your investment gains in the end. 

And that’s exactly what we will be dealing with in this entire chapter. The focus of this segment of Smart Money will be to apprise you of the taxes and conversion charges that you will have to consider when you invest in American stocks. Now, let’s start with tax implications.

Tax implications that you need to consider when you invest in American stocks

When you invest in U.S. stocks, there are primarily two tax situations that you will have to face - taxes on investment gains and taxes on dividends. Let’s deconstruct them one after the other.

Taxes on investment gains

What are investment gains? Simply put, in the context that we’re discussing, they are the profits you make from your investment in American stocks. For example, say you’ve executed the following trade.

  • On April 1, 2020, you purchase 1o shares of Coca Cola at $40 each. 
  • On November 1, 2020, you sell the 10 shares at $50 each.
  • So, overall, you make a gain of $10 per share, or $100 in total. 
  • This is your investment gain from this transaction.

So, do you need to pay taxes on this gain? In the U.S.A, investment gains, also known as capital gains, are not taxed at all. However, in India, these gains are taxed in your hands depending on how long you hold the stocks or the mutual fund units. Although we’ve already covered both the concepts of Long-Term Capital Gains (LTCG) and Short-Term Capital Gains (STCG) in the previous modules of Smart Money, let’s go over them once again since the holding period for foreign stocks are different. 

Long-Term Capital Gains (LTCG)

Now, if you hold American stocks for more than 24 months, they are automatically considered to be long-term holdings. And when you finally sell the stocks, the gains that you realize are categorized as Long-Term Capital Gains (LTCG) and are taxed in India at 20%, with indexation benefits.  

Similarly, if you hold American mutual funds for more than 36 months, they are automatically categorized as long-term holding. And the gains arising from the sale of such mutual funds are treated as Long-Term Capital Gains (LTCG) and taxed in India at 20% with indexation benefits. 

Let’s take up another example to better understand the concept of LTCG. 

  • Assume that you buy a share of Apple Inc. for $40 on February 01, 2019. 
  • The USD-INR exchange rate as on that date is Rs. 71.5. 
  • Now, the total cost of acquisition (excluding conversion charges) comes up to Rs. 2,860 (Rs. 71.5 x $40). 
  • After holding the stock for 24 months, you finally decide to sell it on February 02, 2021 for $130. 
  • The USD-INR exchange rate as on that date is Rs. 73. 
  • Now, the total sale proceeds (excluding conversion charges) comes up to Rs. 9,490 (Rs. 73 x $130). 

Before we calculate Long-Term Capital Gains and the amount of capital gains tax you would have to pay, let’s tabulate the necessary information. 

Particulars

 

Acquisition cost 

Rs. 2,860

Cost of Inflation Index (CII) for the year 2017 - 2018 [purchase year]

272

Cost of Inflation Index (CII) for the year 2020-2021 [sale year]

301

Indexed cost of acquisition

Acquisition cost x (CII of the year of sale ÷ CII of the year of purchase)


Rs. 2,860 x (301 ÷ 272) = Rs. 3,165

 

Long Term Capital Gains Calculation

Sale proceeds

Rs. 9,490

Less: Indexed cost of acquisition

Rs. 3,165

Less: Expenses incurred for the sale

Nil

LTCG

Rs. 6,325

Capital gains tax to be paid

(Rs. 6,325 x 20%)  

Rs. 1,265  

Now that you know how to calculate LTCG and capital gains tax, you can apply the same methodology for mutual funds as well. Just remember that the holding period has to exceed 36 months in order for it to be considered as long-term holdings. 

Short-Term Capital Gains (STCG)

U.S. stock holdings that are less than 24 months and U.S. mutual funds holdings that are less than 36 months are automatically considered as short-term holdings. The gains that you realize from selling these short-term holdings are termed Short-Term Capital Gains (STCG) and are taxed in India at your current income tax slab rate.

Here’s an example to help clear things out for you.

  • Assume that you earn around Rs. 8,00,000 in a year (this would be your total taxable income). 
  • Taking this into consideration, the rate at which you are liable to pay income tax would be 20% (according to the old income tax regime).  
  • Now, let’s say that you purchase a single share of Microsoft Corp. for $217 on January 05, 2021. 
  • The USD-INR exchange rate as on that date is Rs. 73.37. 
  • Now, the total cost of acquisition (excluding conversion charges) comes up to Rs. 15,921 (Rs. 73.37 x $217). 
  • After holding it for a few days, you sell the share for $224 on January 20, 2021. 
  • The USD-INR exchange rate as on that date is Rs. 72.92.
  • Now, the total sale proceeds (excluding conversion charges) comes up to Rs. 16,334 (Rs. 72.92 x $224). 
  • Since the holding period is well below 24 months, the gains of Rs. 413 (Rs. 16,334 - Rs. 15,921) that you realize are automatically termed as Short-Term Capital Gains. 

The STCG that you earned on the sale of this share would be added to your total taxable income, thereby bringing it up to Rs. 8,00,413. Your final total taxable income would then be taxed at the income tax slab rate, which is 20% (excluding cess) in this case.          

Taxes on dividends

With that, you should now have a clear idea on the taxes that you need to pay on your investment gains. Let’s move forward and take a look at the taxes that you would have to pay when you receive dividends.    

In the U.S., dividends that a company pays out to its investors are taxed in the hands of the investor at a flat rate of 25%. And so, if an American company that you’ve invested in pays out $50 worth of dividends, you’ll receive only around $37.5 [$50 - ($50 x 25%)]. The remaining $12.5 would be paid off as tax on dividends.

Similarly, in India too, the dividends that you receive are added to your total taxable income and then taxed at the income tax slab rate that’s applicable to you. So this begs the following question.   

Do I have to pay taxes twice? 

Thankfully, no. We have what is called a Double Taxation Avoidance Agreement (DTAA) between India and the U.S.A. It is essentially a treaty that’s signed by two countries, which in this case are India and the U.S.A, that permits you to claim the taxes paid in the foreign country as a tax credit to offset your tax liability in your home country. 

Here’s an example to help you understand how DTAA works. Let’s take up the previous example itself. 

  • Assume that you received $50 worth of dividends from an American company. 
  • So, you would have paid around $12.5 as tax on February 25, 2021 as taxes on dividends and taken $37.5 with you. 
  • The INR value of $12.5 that you paid as tax on dividend would be Rs. 905 ($12.5 x Rs. 72.39). 

Now, you can claim the tax that you paid in the U.S.A (which we’ve determined to be Rs. 905), as tax credit to lower your income tax liability here in India. Let’s make another assumption here. Say your total taxable income is Rs. 8,00,000.

So, when we add the INR value of the $50 worth of dividends to your total taxable income of Rs. 8,00,000, your total income would come up to Rs. 8,03,619 (Rs. 8,00,000 + [$50 x Rs. 72.39]). Your final total taxable income would then be taxed at the income tax slab rate, which is 20% (excluding cess) in this case. 

Now, you can claim the tax of Rs. 905 as tax credit, since you’ve already paid to the U.S. government to reduce your income tax liability here in India. So, you can successfully avoid double taxation at the hands of both the governments.  

Conversion charges that you need to consider when you invest in American stocks

Taxes aren’t the only things that you need to account for when you invest in U.S. stocks. You also have to consider the Foreign Exchange conversion charges that banks levy for converting INR to USD. This is another major expense that can impact your investment gains considerably.

The USD-INR currency exchange rate that you see everyday is not the same rate that banks charge for converting the two currencies. They add certain other charges and fees for the same. This could invariably end up increasing your costs. 

Here’s an example that can help clear things out for you. 

  • The USD-INR exchange rate for March 02, 2021 is currently at Rs. 73.38.
  • This means that you would have to pay Rs. 73.38 for 1 USD. 

So, when you approach a bank for remitting funds to your overseas trading account, they will most probably not use the exchange rate mentioned above. Instead they will charge an exchange rate of their own. 

And since this is an outward remittance, where you convert INR to USD, the bank would charge a higher exchange rate of - let’s say - Rs. 74.52. The difference between the two exchange rates, Rs. 1.14 (Rs. 74.52 - Rs. 73.38), goes to the bank.

Similarly, in the case of an inward remittance, where you convert USD to INR, the bank would charge a lower exchange rate of - let’s say - Rs. 72.21. The difference between the two exchange rates, Rs. 1.17 (Rs. 73.38 - Rs. 72.21), again goes to the bank. 

Here’s something else that you should know. In addition to the difference in exchange rates, some banks may also levy additional charges like a flat rate fee for providing Forex services. For instance, banks may charge a flat rate fee of Rs. 500 (excluding GST) for remittances up to USD 500 and a flat rate fee of Rs. 1,000 (excluding GST) for remittances above USD 500.

Wrapping up

Whew! This chapter was quite detailed, wasn’t it? We hope that you’ve understood everything there is to know about taxes and conversion charges levied when you’re investing in American stocks. In the next chapter, we’ll deal with how currency movements have an impact on your investments. 

A quick recap

  • When investing in the U.S. stock market, there are primarily two tax situations that you will have to face - taxes on investment gains and taxes on dividends.  
  • In this context, investment gains are the profits you make from your investment in American stocks. 
  • In the U.S.A, investment gains, also known as capital gains, are not taxed at all. However, in India, these gains are taxed in your hands depending on how long you hold the stocks or the mutual fund units. 
  • If you hold American stocks for more than 24 months, they are automatically considered to be long-term holdings. And when you finally sell the stocks, the gains that you realize are categorized as Long-Term Capital Gains (LTCG) and are taxed in India at 20%, with indexation benefits.  
  • Similarly, if you hold American mutual funds for more than 36 months, they are automatically categorized as long-term holding. And the gains arising from the sale of such mutual funds are treated as Long-Term Capital Gains (LTCG) and taxed in India at 20% with indexation benefits. 
  • U.S. stocks holdings that are less than 24 months and U.S. mutual funds holdings that are less than 36 months are automatically considered as short-term holdings. The gains that you realize from selling these short-term holdings are termed Short-Term Capital Gains (STCG) and are taxed in India at your current income tax slab rate.
  • In the U.S., dividends that a company pays out to its investors are taxed in the hands of the investor at a flat rate of 25%. Similarly, in India too, the dividends that you receive are added to your total taxable income and then taxed at the income tax slab rate that’s applicable to you. 
  • But you do not need to bear the burden of taxation twice, because the DTAA between India and the USA permits you to claim the taxes paid in the foreign country as a tax credit to offset your tax liability in your home country.   
  • Taxes aren’t the only things that you need to account for when investing in the American stock market. You also have to consider the Foreign Exchange conversion charges that banks levy for converting INR to USD.
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