Intermediate

Amended as on Apr 1, 2023: Please note that as per amendments in Finance Bill 2023, from April 1, 2023, profits made on investments in debt mutual funds are now taxed as short-term capital gains if these funds invest <=35% in equities. This means, debt mutual funds are now taxed as per the income tax rates as per an individual’s income.

Also note that with effect from Apr 1, 2020, Dividend Distribution Tax (DDT) was abolished, and mutual fund dividends were made taxable in the hands of investors. Dividend income is now considered as ‘income from other sources’ and investors need to pay tax on it as per their individual tax slabs.

This article is currently in the process of getting updated, as it was originally written at a time when tax rules were different. Please treat this note as the latest updated tax information in the meanwhile.

Richa, a 32-year-old entrepreneur, is an active investor. She prefers equities due to the potentially high returns that they offer. Richa has been tracking US stock markets and admires some of the companies listed on that stock exchange. She wishes she could invest in those stocks. She approaches a financial advisor to help her do this. Here is what the advisor tells her:

Benefits of investing in foreign markets:

Richa’s advisor first compliments her on her insight into investing abroad. He recapitulates four key benefits of investing abroad:

First, you enjoy the benefits of diversification. By investing abroad, you reduce the component of ‘country risk’ in your investment portfolio. In other words, if the Indian economy slows down, which may affect your domestic investments, your investments abroad may appreciate as a result of high economic growth in the foreign country.

Second, you have the advantage of investing in a foreign currency. Similar to ‘country risk’, you are also protected from ‘currency risk’. If the Indian currency loses value against the US dollar, your investment in the US will fetch you more Indian rupees, thus resulting in a gain, and vice versa.

Third, you get the opportunity to invest in companies, sectors and themes that may not be available in India. These might include e-commerce, the digital economy, and retail.

Fourth, the amount invested abroad through a feeder fund does not fall within the limits of capital remittance imposed by the Reserve Bank of India (RBI). RBI has stipulated that a maximum of USD 250,000 can be remitted outside India per person per year. In other words, if you want to invest more than this amount in a year, you can do this through a feeder fund without having to restrict your investment to the limit imposed by RBI.

Route to investing abroad

The financial advisor then explains international feeder funds. This is Richa’s route to investing in foreign stocks in an easy and convenient way.
An international feeder fund collects money from local investors for investment abroad. An international feeder fund is a fund-of-funds. That is, it doesn’t invest directly in securities abroad; instead, it invests through its parent fund. The parent fund invests the money in foreign corporations. An international feeder fund can be country-specific, region-specific or theme-based (e.g. consumption, energy, real estate). For instance, a mutual fund can include an international gold fund that is an international feeder fund which garners investments from Indian investors and, in turn, invests its corpus in a global fund that invests in gold mining companies; this global fund is run by the mutual fund’s parent company.

Investment process:

You can invest in an international feeder fund in the same manner as you invest in any mutual fund schemes. You can invest online or offline, directly or through a mutual fund distributor.

Fund expenses:

These funds are similar to any Indian fund in terms of the funds’ management cost.

Risk:

While investing in another currency helps you diversify currency risk, you also face the possibility of reduction in your investment value if the Indian rupee strengthens vis-à-vis the currency of the country in which you have invested. Other than currency risk, there is the risk associated with equity investing. By using the systematic investment plan (SIP) route, where you invest a fixed amount every week, month or quarter, you can reduce the risk associated with equity investing.

Tax implications:

All international feeder funds are Specified Mutual funds i.e. funds (i.e. funds whose allocation to equity shares of domestic companies does not exceed 35%) for taxation purposes. Prior to April 1, 2023, if you held your investment for less than three years, your gains would be taxed based on the tax rate that applied to your total income. If you held your investment for more than three years, you would have paid tax at a rate of 20% plus applicable surcharge and 4% Health and Education cess after considering indexation.

However, in accordance with the Finance Act 2023, if you invest in such Specified Mutual fund after April 1, 2023, your capital gains will be deemed at short term capital gains and accordingly be taxed at the rate determined by your tax slab.

Note: As per Finance Bill 2018, existing 3% Education Cess will be replaced by a 4% Health and Education Cess on the tax plus surcharge.

Monitoring your investments:

As with any investment, it is necessary to monitor your investments in an international feeder fund. This entails keeping track of currency movements and the growth in the market or theme in which you have invested.
Investing in an international feeder fund is suitable provided you are convinced about the growth prospects of the country/sector in which you plan to invest. An additional angle involves the impact of the currency fluctuation on your investment value. At the same time, such funds offer you the benefit of diversification. Invest in such funds after sufficient research or seek the services of a financial advisor.