From Harold’s Perspective
Harold, is a US citizen. Although both his parents were born and raised in the US, he has some Indian connections. Curious about his ancestry, he started traveling frequently to India in his early twenties, and has since then spent a lot of time in India and built several relationships. Around 10 years ago, Harold co-founded a pharmaceutical company in India. The market for pharmaceuticals has exploded, and as a result, the company’s valuation has grown exponentially. The last time the company did a round of funding, they received approximately $10 million. In 3 to 4 years when they are ready for their next round of funding, he expects to raise $30 million
Harold and his family are all US citizens. The pharmaceutical company is a Private Limited company, set up in India.The key issue here, is that the value of the company is going to be well north of the lifetime exemption in the US which today is $23.4 million. This means that if his estate becomes $40 million in the future, the balance $16.6million ($40m – $23.4m) is exposed to estate duty in the US which is as high as 40%.
What should Harold consider here? Today’s value needs to be estimated. Harold needs to carve out whatever he doesn’t need direct access to, and proportion that to his children. The smart thing would be to set up an irrevocable trust in India and make a lifetime gift today (at today’s value of $3 – 4million) to his children. By doing this, if it becomes 4 times that ($16million), then he would have transferred $12 million (16 minus 4) free of tax to his children.
Thus we can see, with some planning, he could switch some of these assets to his children so that the growth happens in his children’s hands, rather than his hands. This allows him to preserve enough assets to be shielded from estate tax. For the rest of the growth, if he transfers it smartly (and earlier) when today’s valuation of the company is lower than what he expects it to be in a few years, then whenever that exit happens, he has already transferred it before he can be exposed to the lifetime estate duty of 40%.
From Prakash’s Perspective:
Prakash, is an Indian citizen living in India with a growing asset in the US. He studied in the US at various points over two decades ago and has several close friends, both Indian and American, in the US. He has close friends from India with children in the US and has kept in touch with the entrepreneurship environment in the US since his business school days in California in the early 2000s. A couple of years ago, during a vacation to the US, Prakash and his friends talked about a startup idea – an app, in the healthcare space – that Prakash invests in. Prakash’s investment into his friend’s company is, essentially, an asset of Prakash’s that is now in the US.
The startup does well and is valued at a billion US dollars in a few years. Suddenly, Prakash, an Indian citizen, has a huge asset in the US which will be subject to estate taxes. The issues here are complex because a US citizen (between a married, filing, joint couple) can have an estate as high as $23.4 million and no estate taxes. When the situation changes and you have a non-resident alien, the exemption amount plummets to just $60,000. In short, if something were to happen to Prakash, and his shares in this startup are $1 million, then everything above $60k is exposed to a $40% estate tax.
The way for Prakash to protect his assets, as a non-resident alien vis-à-vis the US, is that he doesn’t hold the shares in his hands. Instead, he can hold them in a name of a company. Here’s the thing: non-individual structures cannot be taxed. Estate duties by their very nature apply to individuals. What Prakash could have done at the time of investment is to have started a company in India, and then make the investment on the behalf of the company so that the company, not Prakash, owns the interest in the US startup. Even considering FEMA obligations, this is a better way to make an investment in a foreign entity. In doing so, ODI rules need to be kept in Mind.
Contact Ventura Pranas, for such customised solutions to complicated tax-related issues.
