INTRODUCTION
The setting: a technology company, TechWheel, with three founders, Nico, Dev and Asha.
Nico and Dev have been close friends since college and once they started working, they played basketball in the evenings at a local indoor court, where they met and befriended Asha. Together, they founded Tech Wheel in 2004. They had been nurturing TechWheel for a long time, before they received an offer for the company to be bought. All three of them exited, and now they each want to:
1. Optimize taxes on their capital gains from the exit.
2. Set up trusts in the US for estate and income planning
How does the sale play out for each of the founders on the income tax front? This story illustrates their different scenarios in relation to taxation, largely due to their country of residence, despite all of them having US citizenships.
From Nico’s Perspective
Nico met his wife, Prema, during one of his many trips to India and he was keen on heading operations for the company in India. Nico is a US citizen, lives in Bangalore, is married to an Indian citizen, and has two children. One of them is in the United States attending graduate school, and the other lives and works in India.
Problem
Nico is a US citizen, so he is eligible for QSBS and can exclude gains to the extent of the higher of 10 times basis or $10 million. He is also an Indian resident applying number of days under income tax, so although in the US they are tax free, in India they are exposed to 28.45% with the Indian high 37% surcharge.
He is also exposed to US Estate Duty and wants to set up irrevocable trusts for the benefit of their children and spouses.
And if he is an Indian resident under FEMA, he can’t set up a foreign trust by contributing foreign stock without RBI permissions unless they can prove they are either a non-resident, or the assets were purchased out of NRI earnings.
Solution
Nico can contribute stock to a non-grantor trust in a non-taxable US state, exempting their capital gains under QSBS and assets under Indian income tax.
We established that he is a resident of India under income tax rules but as an NRI under FEMA rules. In addition, the asset was first purchased out of NRI earnings abroad, allowing him to open a trust in the US to contribute the assets.
From Dev’s Perspective
Dev, the second co-founder, is also a US citizen living in India, but his wife who is the third co-founder, lives in the US. Dev’s wife Asha is a US citizen. Together, they have two children who are both in school.
Problem
Dev is a US citizen, so he is eligible for QSBS and can exclude gains to the extent of the higher of 10 times basis or $10 million. He is also an Indian resident applying number of days under income tax, so although in the US they are tax free, in India they are exposed to 28.45% with the Indian high 37% surcharge.
He is also exposed to US Estate Duty and wants to set up irrevocable trusts for the benefit of their children and spouses.
And if he is an Indian resident under FEMA, he can’t set up a foreign trust by contributing foreign stock without RBI permissions unless they can prove they are either a non-resident, or the assets were purchased out of NRI earnings.
Solution
Dev can contribute stock to a non-grantor trust in a non-taxable US state, exempting their capital gains under QSBS and assets under Indian income tax.
He needs to establish that he is an income tax resident of the US by applying the DTAA tie-breaker rules, accruing tax savings. Further, we established him as a non-resident under FEMA, so he could set up a non-grantor foreign trust in Nevada, US, receiving the $10 million exemption under QSBS.
From Asha’s Perspective
Asha, the third co-founder, chose to live in the US, and she has the support of her family to help her raise her children. Both she and her husband, Dev, fly back and forth frequently to spend time together.
Problem
Asha is a US citizen, so she is eligible for QSBS and can exclude gains to the extent of the higher of 10 times basis or $10 million. She is also living in the US and has potentially no tax in the US to the extent of the higher of 10 times basis or $10 million.
She is also exposed to US Estate Duty and wants to set up irrevocable trusts for the benefit of their children and spouses.
Solution
As a US resident, she is free to set up any trust in the US without let or hinderance for income and estate tax planning. She can set up a non-grantor or grantor trust in a non-taxable US state.
Asha can contribute stock to a non-grantor or a grantor trust in the US, in a non-taxable state, exempting her capital gains under QSBS.
Since it’s easy to establish Asha as an NRI for both income tax and FEMA, we advised her to set up two trusts – one grantor and one non-grantor – in the US and was able to receive twice the QSBS exemptions.
EXPLANATION
This sale involved the sale of a US parent company with an Indian subsidiary. The Indian subsidiary is less than 50% of the value upon sale and therefore, there was no indirect tax attribution to India. It was also a Qualified Small Business Stock (QSBS).
Setting up a non-grantor trust in a non-taxable US state will ensure the capital gains will remain exempt under the QSBS rules. It can also ensure the assets and income in the trust fall outside the ambit of the Indian Income tax authorities.
Since Asha, unlike Nico or Dev, is not subject to taxes in India, she can set this up as either a grantor or a non-grantor trust. A grantor trust will ensure taxation in her hands. Non-grantors will be at the trust shrunken slabs. However, if all the gains are capital gains, it will not matter. The taxpayer can potentially use two $10 million exemptions between the grantor and non-grantor trust and accomplish estate and huge income tax benefits.
Contact Ventura Pranas, for such customised solutions to complicated tax-related issues.
