The application of Section 54F and how it can impact taxpayers in India who are non US citizens holding stock in a US company.

April 24, 2024

INTRODUCTION

In this issue, we focus on the application of Section 54F (exemption from capital gains with certain conditions met), and how it can impact taxpayers in India who are non US citizens holding stock in a US company. We will thoroughly examine the case of Hiten (an Indian citizen) and Mark (a US citizen) to understand in great details, the implications of Section 54F of the Indian Tax Act that allows an exemption on capital gain from sale of any property other than a residential house. This exemption is subject to certain conditions.

From Hiten’s Perspective

Hiten grew up in Himachal, but after his graduate studies in Delhi, shifted to Bangalore working for a US automobile company. Through the same company, he went to the US in 2009. He stayed on in the US until 2017, although in between he switched jobs a couple of times. In 2017, he decided to move back to India to raise his young children. He remained on a nonimmigrant visa and did not apply for a Greencard as he always knew he wanted to return to India.

Problem

While Hiten worked in the US, he was allotted stocks in a company. He exercised these shares and paid in the grant price when he had a sense that he would leave for India soon. Within a few years of shifting back to Bangalore, his base in India, the company went public in 2021. Hiten made capital gains from the sale as he met all the holding conditions that relate to an Incentive Stock Option (ISO). The sale resulted in long term capital gains in both US and in India. In India the holding period for foreign stock is 2 years. Hiten met this criteria as well. Since Hiten now lives in India and has spent less than 183 days in the US during the year that the company went public, all the capital gains get taxed in India. He has no federal or state liability, but Indian long term capital gains tax can be as high as 28.5%. What can Hiten do to mitigate taxes?

Solution

Hiten could invest in 54F property.The capital gains from the property sale is exempt only in the proportion of the sale proceeds ploughed back into the repurchase of the new property. Hiten would need to hold this property for 3 years and not purchase any other property invoking provisions of section 54F for another 3 years. Also, because all of this stock was purchase out of funds earned during his US residency days, all of the proceeds can be left in the US.

From Mark’s Perspective

Mark Singh, a US citizen who was living in India from 2005- 2016 and he was holding stock in an Indian company. Mark was married to an Indian resident for many years, and a couple of years after they parted ways, he decided to move back to the US. Mark exercised his stocks before he moved back to Colorado in 2016.

Problem

In the US, Mark’s holding conditions for long term (i.e. 12 months from exercise) is met, and in India (2 years from exercise in the case of an unlisted stock) is also met. When capital gains occurs for Mark, he has to first file in India (in other words, the gains has to be offered to be taxed in India first) before he files in the US. In India he can invoke the savings under section 54F, but the same won’t yield savings in tax in the US. He will still have to pay the tax in the US at a federal level and if he stays in a taxable state (which Colorado is), then he will have to pay a state tax too.

Solution

He might be better off, therefore, to sell in India, pay tax in India and use the credits against the US taxes. Mark Singh will still have to pay NII (Net Investment Income) tax of 3.8%, but that’s still a better outcome than paying a whopping 23.8% at a federal level plus the state taxes of 6% over and above the investment in India to meet the specifications of 54F. Mark might just find himself in a bit of cash crunch and still ends up paying close to 30% in US taxes.

EXPLANATION

The upcoming change in capital gains rates in the US might affect you if you have property in India. Next year, it’s very likely that the Biden administration capital gains proposal goes through, which means that the capital gains rate is going to up to ordinary rates once someone’s income exceeds $1 million. So if you take an individual is going to sell even property in India that’s worth over a couple of million dollars of gains, he’s going to be paying the US tax of 43% versus the Indian capital gains rate that’s 28.5%. If that might be you, this is the time to sell. If you’re not going to sell, then making some transfers well before the date of sale (or rather, well before next year) maybe one to consider.

Contact Ventura Pranas, for such customised solutions to complicated tax-related issues.