Taxation and Regulations

01 Nov 2022 - Tanmay Jha

This article describes my experience with financial planning when returning to India. In general, it’s a good idea to diversify your assets by having exposure to different currencies and economies . If one country makes bad economic decisions, you will still have assets in a different currency to help tide you over. For this reason, I wanted to spread my assets and savings between US and India. Here is my experience when evaluating different asset classes and factors

Taxation And Regulation
Retirement Accounts
Ireland Domiciled Funds Loophole
Estate Taxes
Health Savings Account
Continuing To own US Assets

1. Taxation and regulation

Disclaimer - I am neither an accountant nor a tax lawyer. Any advice here does not constitute tax advice or legal advice. Please consult a tax attorney or an accountant for your personal situation

Taxation gets extremely complicated when you are a tax resident of one country, and have investments in a different country. Detailed tax planning is beyond the scope of this blog, but here are some things to keep in mind -

If you are not a US citizen/permanent resident, you will likely become a nonresident alien from the next US tax year. In India, depending on how long you have been away, you may qualify for temporary RNOR status where your non-Indian income is not subject to taxation by the Indian government. (Link for RNOR status guide)
US government does not impose capital gains taxes on non-resident aliens. If you have a window where your RNOR status (India) and nonresident status (US) overlap, you will not be paying Capital Gains taxes on your US capital gains to either government. This is a great time to sell everything you own and repurchase it, thus re-setting your cost basis. Say you purchased a stock at $1, and it currently trades at $9. By selling it and re-purchasing it, you reset your cost basis to $9 and pay no taxes to anyone (because of RNOR/nonresident alien status). If in the future(once your RNOR status expires), you sell it at $12, your taxable profit will only be $12- $9 = $3, instead of $12 - $1 = $11.
Even during this RNOR/non-resident overlap, you will have to pay taxes on dividends/interest earned in the US, but only to US government.
Once your RNOR status expires, things get more complicated:
- Capital Gains - US government will still not charge/withhold taxes on capital gains, but now the Indian government will be taxing your worldwide income, including US capital gains, dividends and interest income. Even in this scenario, US capital gains are relatively easy to handle because you only owe taxes to one government (Indian), so the question of double taxation does not arise. (Make sure to supply form W8-BEN certifying your nonresident status to your US brokerage at the beginning of the tax year).
- Dividends - US dividends and interest will now be subject to both US and Indian taxes. While in theory double taxation is easy to avoid because of foreign tax credits, in practice its not so cut and dry. Because US tax year runs from Jan - Dec, and Indian tax year runs from April - March, your tax forms will not translate over. So for the purpose of Indian tax filing, you will have to manually calculate your gains/dividends/interests for the relevant period from your statements, considerably increasing hassle.
  
  US will tax your dividends at a 25% rate (assuming you supplied the correct W8-BEN to the withholding institution, since US India DTAA reduces this rate from 30% to 25%). When you file your taxes in India, in theory you should be able to claim this as foreign tax credit. However, there are two caveats:
  - To the best of my understanding, if the amount of US tax is more than your Indian tax liability, you won’t be getting a refund from the Indian government. So you claim a foreign tax credit (FTC) of $25 based on US taxes, and according to Indian tax law you only owed $20, there won’t be a $5 refund issued by the Indian government
  - More importantly, foreign tax credits are not automatically processed by the CPC. So if you are claiming FTC, then your taxes may be referred to an assessing officer. This can bring more headache than its worth, and your CA may advise you to drop small amounts of FTC and just take the loss
- Bank interest is tax exempt for nonresident aliens in the US, so it will only be taxable in India
- Due to the more favorable tax treatment for capital gains (instead of dividends), one recommended strategy is to move your investments to growth stocks instead of dividend bearing stocks
- A recommended approach is to invest in Ireland/EU domiciled UCITS ETFs, discussed below.
FEMA - Foreign Exchange Management Act regulates inflow and outflow of foreign exchange in India. This is independent from the tax code, and it is important to discuss the implications of FEMA with your CA when creating your financial strategy.

2. Retirement accounts

What to do with your 401(k), Roth 401(k), IRA, Roth IRA? This is a complicated topic.

Fortunately, the Indian government recently released a notification saying they will treat foreign retirement accounts as retirement accounts for tax purposes of Indian residents. Previously, it was not clear if these would be treated as brokerage accounts or retirement accounts. What this means is if you executed a trade in your 401(k) that gave you a $10 profit, that profit would be tax deferred according to US tax laws. However, Indian government might tax you saying its just a trade with $10 profit. Now when you withdraw money from your 401(k) in retirement, US government will demand taxes on this profit too, and since that will be a different tax year, foreign tax credit won’t be available either. In practice, this would mean double taxation. Thankfully, the recent government notification should prevent this.
Here are some of the options you have
- Leaving the money as is - this is a good option if you are unsure about future plans and don’t have an immediate need for that cash. Let it stay invested in your 401(k), and start withdrawing it after you reach retirement age.
- Rolling over your 401(k) to an IRA, and a Roth 401(k) to a Roth IRA - this will get your money out of your employer managed 401(k) to a self managed account. This will let you avoid any management fees. It will also give you more autonomy, in case you like to manage your own investments. Since you are changing traditional to traditional, and Roth to Roth, you shouldn’t face any tax consequences for this.
- Rollover your traditional account to a Roth account - There are two advantages of this move -
  1. Tax planning - You will have to pay taxes today on the entire conversion amount, but when you withdraw the sum at retirement, both the principal and the earnings will be tax free. If you are withdrawing money from a Roth account after retirement age, it shouldn’t be considered a taxable event in either US or India.
  2. Premature withdrawal - If you prematurely withdraw money from a traditional account, you have to pay owed taxes as well as a 10% penalty. This penalty goes away for Roth accounts. If you anticipate a need for accessing your retirement nest prematurely (not a good idea!), this method may be beneficial. Say you have a 100K balance in your traditional 401(k), with a total contribution amount of 50K (rest 50K is growth).
    - If you withdraw the entire amount today, you pay taxes and 10% penalty. Assuming your marginal tax rate is 30%, you are left with 60K
    - If you roll over the entire amount to Roth, you need still need to pay 30% tax, but not the penalty. So you will have to pay 30K in taxes out of pocket, and the entire 100K rolls over into a Roth account. You have to wait 5 years before any withdrawals after such a conversion. For the purpose of withdrawing from the Roth account, this 100K is now your contribution and the entire 100K can be withdrawn prematurely (after 5 years) with zero taxes and penalties. Any growth over the 100K will be subject to taxes and penalties in case of a premature withdrawal, and will be free of taxes and penalties if withdrawn after the appropriate age limit. By doing this move, you managed to save 10K (100K minus 30K you paid in taxes is 70K, versus 60K from point a). The opportunity cost is paying 30K upfront and waiting 5 years. The benefit is saving 10k and reducing tax headache
      1. You can further reduce this 30K in taxes by splitting the rollover amount across multiple years. Once you have left the US, your taxable income in the US will most likely be much lower. You can structure your rollovers so that your marginal rate is lower than 30 percent
      2. There is however an important caveat to the above point. Apparently when you do a traditional to Roth rollover as a nonresident, then there is a mandatory withholding of 30%. So instead of the above case (you paid 30K upfront and the entire 100K balance got transferred to Roth), now out of the 100K, 30K will be withheld as taxes and only 70K will be transferred to Roth. Furthermore, this 30K withholding will be considered a premature withdrawal, and will attract a 10% early withdrawal penalty. So in this case, out of a total balance of 100K, you lose 33K (30K in tax, 3K in penalty). The remaining 66K can be withdrawn from your Roth account after 5 years. It is not fully clear to me what happens when your marginal rate is lower than the rate of withholding (say you only rollover 10K each year, and have no other US income, so your marginal rate is 10%). In this case, is the liability rate 30% or 10%? If so, do you get a refund on filing your taxes? I don’t yet have the answer to these questions, but these are things you can ask your CPA when you are planning what to do with your retirement accounts.

3. Ireland domiciled funds loophole

Main source of knowledge - Bogleheads article on nonresident alien investors
You have the option of swapping out your US domiciled ETFs for equivalent Ireland domiciled ETFs -
1. These consist of pretty much the same underlying assets(eg. S&P 500 can be purchased as VOO(US version) or VUSD(Ireland domiciled version)). The main difference is that these funds themselves are domiciled in Ireland, so even though they compose of the exact same securities, the taxation and withholding rules are significantly different for US nonresidents.
2. There is a difference in liquidity and trading volumes. You are not allowed to purchase the Ireland domiciled version as a US resident.
3. In return for accepting lower liquidity and slightly higher fees, you eliminate your US tax liability on dividends. This is a massive benefit for tax compliance, since you don’t have to report and pay US taxes on these dividends yourself.
  
  Note - You still lose 15 percent via indirect withholding tax on dividends paid by the US security to the Ireland domiciled ETF, but that is still less than 30 percent you would lose with an equivalent US domiciled ETF (25 percent for Indians due to India-US DTAA). Moreover, you don’t have to handle this tax yourself, since it will be handled by the Irish ETF on their end. As long as you are nonresident in Ireland, Ireland won’t impose any taxes/withholdings on dividends distributed by the Irish domiciled ETF to you. Link to further reading
4. Investing in these also saves you from the estate tax trap, discussed more in detail in the estate tax section
5. By choosing Irish domiciled funds, you also get the freedom to invest in accumulating ETFs (eg VUAA, the accumulating version of VUSD). I haven’t cross checked this my CPA yet, but this likely means you won’t have to report and pay tax on these dividends to the Indian government either, since the dividends don’t get distributed to you. They simply get reinvested into the fund, increasing your NAV. You will eventually pay capital gains tax on this amount when you sell your shares, so the main benefit is it removes the hassle of calculating and reporting dividends every year. US domiciled ETFs and mutual funds have to distribute at least 90% of their income to shareholders, so this option is not available there.
  - The 15% international withholding tax/dividend tax leakage will still apply here

TLDR - Using an Irish Domiciled ETF is quite beneficial for nonresident aliens. It eliminates your US tax liability on dividends. If you switch to accumulating ETFs, you will likely also avoid Indian tax liability on dividends and only have to deal with capital gains. This method also saves you from the estate tax trap

4. Estate Taxes

If you are a US citizen or permanent resident, US estate taxes only kick in above a very high threshold - $11.2 million. However, if you are a nonresident alien, estate taxes kick in at an extremely low threshold - $60,000. Any US assets you have above this threshold will face a 40% inheritance tax in the absence of an estate tax treaty between the US and your country. India does not have an estate tax treaty with the US. An easy mitigation is switching over your investments to Ireland domiciled ETFs, since then you are not directly holding US assets and your Ireland domiciled holdings don’t fall under the US estate tax purview (recommended reading from bogleheads)

Most of my knowledge on this section comes from discussions with a colleague who was knowledgeable in this area, and from Bogleheads and R2I club forum. I have been unable to find a tax/wealth advisor in India or US who is very knowledgeable about this (please let me know if you find one). This is more important for people with dependents.

5. Health Savings account

This one is probably the easiest. Continue to hold it as-is, and maybe turn the balance into investments. Make sure to move it to a provider that doesn’t charge any fees (e.g. Fidelity). You can just leave the money alone and let it grow, and use it in case you ever move back to the US. Alternatively, you can request reimbursements for any medical expenses you incur in India. These should be tax free in both US and India.

6. Continuing to own US assets

These have been discussed elsewhere, but here is a quick recap

Open brokerage and retirement accounts with Schwab One, IBKR and TD Ameritrade. They will let you maintain them once you are a non-resident and having multiple ones lets you roll over your assets in case one institution stops catering to nonresidents. You will not be able to open new accounts once you are a non resident
- Once you become a non-resident, notify your brokerage and bank by giving them a W8-BEN. This is crucial, and should be done at the beginning of the year. This lets them make sure their withholdings are correct (zero for capital gains) and that they don’t generate incorrect tax forms (I believe a nonresident gets a 1042S instead of 1099B etc.)
Move cash to banks that support nonresident aliens. My best recommendations are first tech federal credit union and Amex Checkings. These also support google voice numbers to the best of my knowledge
- As an alternative use the checking account feature from your brokerage. Brokerages like Fidelity, Schwab One etc offer this feature and are more compatible with nonresident aliens and google voice than most banks. In fact, IBKR let me use an international phone number for 2FA.
- A second alternative to simply continuing to hold USD deposits with Indian banks is RFC accounts
Indian government does not prevent you from holding overseas bank, investment or retirement accounts. Taxation can get a little complicated depending on your residential status and tax treaties, but you should be able to continue holding most of your US assets as long as the service provider (bank/investment firm) serves nonresident aliens.