Investing globally through foreign brokers; taxes & transaction costs

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This blog post is based on my own experiences of investing in global markets directly through foreign brokers as against the more common route of investing through international funds domiciled in India.

My belief is that investing through the international funds domiciled in India is not a great option (the key reason is an extremely poor choice of available funds coupled with high expense ratios) making it worthwhile to also explore investing directly in global markets even though that comes with its own challenges.

Please note that here we are primarily talking of investing globally but through stocks/funds/ETFs domiciled in the US. I have covered 2 aspects related to investing through 2 foreign brokers – IBKR (interactive brokers) & TD Ameritrade.

  1. Tax compliance
  2. Transaction costs & overall experience.

Section 1: Tax compliance while investing in US-based securities through foreign brokers.

Please note that, under the LRS (liberalized remittance scheme) operated by RBI, Indian citizens can invest up to 250k USD per person per year. Please note that to improve tax compliance, the finance bill 2020 has proposed a 5% TCS (tax collected at source) to be imposed on any remittances out of India. This tax is not an additional tax and can be adjusted against the final tax liability. Also, this tax comes into effect if the total remittance exceeds 7 lacs in the year. 

Taxes

Given that this route has foreign exchange being used to invest directly in the US markets, you have to deal with more complexity straight away since you need to understand the tax laws that are applicable to you in both countries and comply with both.

US tax resident status

For all practical purposes, Indian citizens who have no major business dealing in or are not living/traveling for long periods of time to the US during the financial year in question will be classified as non-resident aliens (NRAs).

The IRS (Internal revenue service, US) site says, “An alien is any individual who is not a U.S. citizen or U.S. national. A nonresident alien is an alien who has not passed the green card test or the substantial presence test”.

NRAs do not have to pay tax on their worldwide income. Only their US income is subject to US tax. So all points below only apply to their US assets/gains and exclude their assets/gains in India & the rest of the world.

Capital gains on investments in the US

US taxation – There are no capital gains applicable for NRAs – this holds irrespective of any classification of the gains as short or long term.

India taxation – Any capital gains in the US will be treated similar to investments in debt funds in India – i.e. short term capital gains (less than 3 years) at applicable Indian tax rate & for long term capital gains (>= 3 years) getting taxed at 20% with indexation.

Dividend income tax

US taxation – Dividend income will be taxed at 30%. However, given the DTAA (double taxation avoidance agreement in effect between the US and India), this is effectively reduced to 25%. Both the brokers that I have worked with deduct this 25% at source (TDS) and pass on only the post-tax dividend gains to me.

Given the DTAA between India and the US, I should be able to avoid double taxation and get the 25% TDS on my dividend income adjusted while filing tax returns in India. My understanding is that to able to get this credit, I will need to get form 1042-S from my US broker. I believe that this form is typically issued sometime in Jan-Feb which is after the end of the US financial year in Dec.

Estate & gift taxes

One of the major stumbling blocks to looking at investing in US securities has been the estate (inheritance) tax that is applicable for NRAs.

Estate tax – A slab wise rate with a max of 40% tax applies to NRAs w.r.t US situated assets with an exemption of up to 60k USD (only available for transfers at death). So this means, that the US government could lay claim to 40% of your total US situated assets above the exemption limit of ~42 lacs basis current exchange rates!

Gift taxes – none applicable for NRAs.

The following table sums up my understanding. 

Estate and gift taxes
*I am not sure what applies to mutual funds / ETFs which invest outside the US.   **Different reports giving a conflicting picture.

Please note that the rules to establish NRA status are different for estate and gift tax than for income tax / capital gains and is based on ‘current residence + intended domicile status’. However, in my opinion, most Indian citizens primarily residing in India and not planning to move to the US will still end up being classified as NRAs.

If you want to read more on this, suggest reading this, this & this to start with.

Tax compliance by the broker

Nonresident alien individuals fill out W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting – Individuals) and furnish it to the broker – I did this when I signed up with each of the two brokers – this form basically helps me establish my NRA status.

The broker then withholds taxes on U.S.-source dividends at the appropriate tax treaty rates, or 30% if there is no tax treaty, and pays those taxes to the IRS directly. As a withholding agent, the broker is required to report all U.S.-source FDAP (passive income such as interest, dividends, rents or royalties) to the IRS and the client on Form 1042-S.

Tax compliance by the NRA (i.e. by Indian investors).

Are NRAs required to file returns in the US? While getting a definitive answer in black & white has been very difficult, my understanding is the answer is no.

Section A, from the section on taxation of NRAs on the IRS website, states the following conditions under which returns are needed to be filed

If you are any of the following, you must file a return:

  1. A nonresident alien individual engaged or considered to be engaged in a trade or business in the United States during the year.
  2. A nonresident alien individual who is not engaged in a trade or business in the United States and has U.S. income on which the tax liability was not satisfied by the withholding of tax at the source.
  3. A representative or agent responsible for filing the return of an individual described in (1) or (2),
  4. A fiduciary for a nonresident alien estate or trust, or
  5. A resident or domestic fiduciary, or other person, charged with the care of the person or property of a nonresident individual may be required to file an income tax return for that individual and pay the tax (Refer to Treas. Reg. 1.6012-3(b))”.

The relevant point for me is the point 2 & since I am not engaged in trade or business in the US and my broker is withholding TDS on my dividend income, I am not required to file returns in the US.

This is my understanding after all the research I have done. If you have a different understanding of this subject, please do share your comments.

Dates for filing returns if applicable

April 15, or the following business day if April 15 falls on a weekend or holiday of the year following the end of the tax year (Jan to Dec in the US) to which the return relates.

The different definition of financial year in the US and India potentially creates a slight challenge when filing tax returns in India: for e.g. when filing returns in India for FY 20, any US tax certificates like 1042-S will be for Jan 19 to Dec 19 period implying that there is gap you will have to explain for Jan 20 to March 20.

Finding tax consultants in India to help with the laws.

In my experience, this is not easy. You need to find someone who can help you deal with both the US and the Indian laws. For filing tax returns in the US, your consultant needs to be a tax return preparer. Further, he must have experience in preparing returns specifically for non-immigrant foreigners – a general experience may not do. In all likelihood, you will need to work with two tax consultants directly or indirectly – one for each country.

I bought a paid service on Cleartax for helping me figure out the US tax return filing – However, despite 2-3 attempts by them, they could not find a practicing expert who could help me with it.

Section 2: Transaction costs and overall experience when dealing with foreign brokers.

In the section below, I share my experiences of working with a) Interactive brokers b) TD Ameritrade.

Account opening process

Account opening experience comparison
*IBKR site mentions a ‘friends and family advisor’ account as an option. I am not sure this serves the same purpose as that of a joint account i.e. common ownership and hassle free experience in case one of the owners expires. I ended up signing for an individual account and later was consistently told by IBKR that a joint account was not possible unless I was a trader. Should be checked carefully when signing up. This has been the primary reason why I have recently moved from IBKR to Ameritrade.

Overall, the account opening process was similar for both. The only hiccup was with Ameritrade when they declined to help with resetting the password on email and I was forced to call them up on their US number.

Funding the account

The table below primarily covers wire transfer only since that seems the only relevant option for Indian investors funding their accounts from their local banks in India.

Account funding process comparison
*Not tested yet, as so far I have only transferred my holdings (including cash) to Ameritrade from IBKR and am yet to put fresh funds into my Ameritrade account.

Currency conversion spread

For IBKR, the currency exchange spread seems to be about 2.25-2.4% in general. I compared the effective rates for my transfer with what it showed up on Google on the day of the transfer.

For Ameritrade, as mentioned above, I have not yet loaded funds into my account (except transferring cash holdings from IBKR in USD) so I am not able to comment on the typical currency conversion charges.

Trading fees

While when I started investing through the 2 brokers, there used to be a variety of fees (trading fees, monthly fixed commission, etc.) for each one of them. For e.g. IBKR used to charge 1 USD per transaction while simultaneously ensuring that the minimum monthly commission charge to me was atleast 10 USD whether I did 10 transactions or not. Similarly, while Ameritrade had no minimum monthly transaction charge, it used to charge 6.95 USD per month but there is no minimum monthly commission (i.e. if I have zero trades in a month, I don’t pay any commission). Essentially, IBKR pricing is aimed at frequent traders / brokers, while Ameritrade pricing suits buy and hold or infrequent traders.

Since Sept 2019 however, the US online brokers have seen a massive shift to practically zero fees (initiated by Charles Schwab). As a result, this has forced both IBKR and Ameritrade to also fall in line to protect market shares.

For these two brokers, the table below summarizes my latest understanding of the transaction related fees. As you can see, while fees for ETF and US stocks is zero, for other types of securities, it is not fully nil.

Transaction fees comparison-min
*IBKR lite is a new app targeted for the common investors. For corporate traders, brokers, the legacy IBKR pro app continues which has more features and higher commissions.

Overall, I find the pricing structure for Ameritrade to still be much simpler and easy to understand than for Ameritrade.

Withdrawal

The table below primarily covers wire transfer only since that seems the only relevant option for Indian investors wanting to withdraw funds to their local banks in India.  

Cash withdrawal process comparison
*not tested except when I transferred my holdings to Ameritrade which took some time.

Trading – features

Overall, I find the Ameritrade website a much cleaner/brighter than IBKR and more simple to use. However, one key difference in favor of IBKR seems to be the product range which is significantly wider there.

Trading features comparison
*As per brokerchooser.com  
**Please note that given the time zone difference, Indian investors typically have to atleast wait overnight to get a response.

Broker credentials & safety

This should be an important element when choosing a broker. The primary reason I guess is that you are dealing with foreign entities here where the ability to influence/control things should something go wrong is less and hence a higher level of effort to understand the broker’s credentials are required.

The following data should give some idea of investing through each broker. I have put the table below by using a combination of Wikipedia and brokerchooser.com.

Brokers credentials comparison
* FY18.

It would help to cross-check the financial numbers once again whenever you are planning to start investing through foreign brokers. I say this since the broker’s landscape is likely to significant consolidation through mergers & acquisitions given the impact on revenues created by the movement towards zero fees from late Sept / early Oct of 2019. Charles Schwab acquiring TD Ameritrade in Nov 2019 is one such example.

Overall evaluation

Overall evaluation summary

On an overall basis, Ameritrade is my choice. The differential with IBKR on fees has reduced now, the UX is much better & the joint account availability was a major factor for me.

Final comments.

It should be clear from the note above that when investing in global markets through foreign brokers, taxation and transaction costs become key variables to manage. The pros & cons compared to investing through international funds domiciled in India need to be compared with carefully before deciding the appropriate route. 

The above commentary is based on my experience and research. Looking forward to comments from readers that improve the body of the information above.  

 

Global diversification series

This blog post is the fourth & last post of a series on global diversification for Indian investors. You can read the first three parts of this series through the links below.

  1. Why-global-diversification-is-a-must-for-Indian-investors
  2. International-funds-an-in-depth-look
  3. Investing globally through US markets: An option for Indian investors

Disclaimer: The above facts are basis my own research around the beginning of Nov 2019. If there are any errors, please do point them out in the comments below and I will happy to correct them.

One thought on “Investing globally through foreign brokers; taxes & transaction costs

  1. Excellent write-up Amit.
    Finally, found time to read this.
    Estate Tax (in addition to access by family) remains the biggest drawback in my opinion. Any clarity about how estate tax applies to joint accounts?
    TCS on remittances under LRS is another problem going forward.

Happy to hear your views too!

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