Budget 2024: Change in LTCG Taxation on International Funds – Should You Consider Investing?
In the July 2024 Budget, the Finance Minister announced changes in the Long Term Capital Gain (LTCG) taxation for some asset classes. These include equity fund of funds (FoFs), international equity FoFs, gold mutual funds, etc. Earlier, these were subject to taxation at the individual’s slab rate due to a change in the taxation of debt mutual funds in the previous budget. After the recent LTCG changes, the appeal of these asset classes has increased. In this article, we will understand what international equity mutual funds are, their features, how they are taxed, and whether you should invest in them.
What Are International Equity Funds?
International equity funds collect money from domestic investors in India and deploy it in shares of companies listed on foreign stock exchanges. For example, international equity funds can give domestic investors in India an opportunity to invest in global companies like Apple, Amazon, Pepsico, Exxon Mobil, etc., sitting right here in India. Some people refer to these funds as foreign equity mutual funds.
Now that we understand what are international funds, let us look at how they work.
How Do International Equity Funds Work?
Most international equity funds use the fund of funds (FoF) route for investing in international equities. The Indian international fund acts like a feeder fund that collects money from domestic investors in India. The money is then passed on to an overseas mutual fund (master fund). The fund manager of the master fund further invests the money in equity shares of foreign companies listed on foreign stock exchanges like the Nasdaq, New York Stock Exchange (NYSE), etc.
Factors to Consider Before Investing in International Funds
Some factors you should consider when investing in international funds include the following.
1) Geopolitical Risks
The stocks listed in a foreign country are subjected to geopolitical risks and other risks. For example, when Donald Trump was the US President, there was a trade war between the US and China. Trump imposed tariffs on Chinese imports in the US. China reciprocated by imposing tariffs on US exports to China. As a result, companies from both countries suffered as their exports dropped, resulting in lower income and profitability.
Similarly, in 2021-22, inflation rose to a multi-decade high in the US. To fight inflation, the US Federal Reserve raised interest rates in the US to multi-year highs. The high interest rates impacted discretionary spending, leading companies to either hold or cut their budgets. It impacted the demand for software services, leading to a big fall in the share prices of Nasdaq-listed IT companies.
2) Currency Movement
When you invest in international companies, you are exposed to currency risks. Fortunately, the Indian Rupee (INR) has depreciated against the US Dollar (USD) over the years, which adds to the returns from USD investments in US companies.
However, if the INR appreciates against the USD, it will adversely impact the returns of domestic investors from USD investments in US companies.
3) Limited Understanding of International Markets
There is limited understanding of international markets for Indian investors. While enough information is available on markets like the US, there is limited information available on markets like China. Hence, taking an investment call based on limited information is risky. Besides, there is a risk of Government clampdown on certain sectors. For example, the Chinese Government went after e-commerce companies in the last couple of years, impacting their business.
Taxation of International Equity Funds
The taxation of the capital gains on international equity funds depends on the holding period. If the holding period is less than 24 months, the capital gains will be categorised as short-term capital gains (STCG). The STCG is added to the individual’s overall income, and the STCG tax is levied at the slab rate.
If the holding period is more than 24 months, the capital gains will be categorised as long-term capital gain (LTCG). The LTCG tax is levied at 12.5% without the indexation benefit.
Should You Invest in International Funds?
India is one of the world's fastest-growing economies and is expected to maintain this growth momentum. India's current GDP is above $3.5 trillion. According to the Finance Ministry, India's GDP is expected to surpass $5 trillion by FY 2028. By 2047, the Government aims to make India a developed economy with a GDP of $30 trillion or higher. So, there are enough growth opportunities in India in the next 23 years (FY 2047 and beyond) during our transition from a $3.5 trillion economy to a $30 trillion economy.
The benefits of the India growth story will percolate to companies listed on the Indian stock exchanges and their investors. So, keeping these growth prospects aside, should you invest in international funds? Well, that will not be a wise decision.
Investors should first focus on building a diversified equity portfolio in India. Your portfolio should include large, mid, small, and flexi-cap mutual funds. You should work with an investment expert. They can help you identify your financial goals, make a goal plan, and recommend the appropriate equity mutual funds to achieve them.
Once you have built a diversified equity portfolio in India, you may allocate a small percentage of your portfolio to other opportunities. These can include sectoral, thematic, smart-beta, and international funds. However, you may limit your overall exposure to these to 5-10% of your overall portfolio.
FAQ's
What Are the Types of International Mutual Funds Available?
There are various types of international mutual funds available for Indian investors. Some of these include the following:
- Diversified funds that provide exposure to a wide set of companies belonging to various sectors. For example, a fund investing in the US S&P 500 Index.
- Funds providing exposure to companies belonging to one or limited sectors or theme. For example, a fund investing in the Nasdaq 100 Index that has high exposure to IT companies. Similarly, there are sectoral international funds with exposure to mining, agriculture, etc.
- Funds providing exposure to companies listed in specific countries. For example, there are international funds that provide exposure to companies in specific countries like Brazil, China, etc.
- Funds providing exposure to other asset classes like real estate. For example, international funds that give exposure to real estate in foreign countries by investing in real estate investment trusts (REITs) listed in those countries.
How Does the Concept of Feeder and Master Fund Work in International Mutual Funds?
Let us understand this with the help of an example. The PGIM India Global Equity Opportunities Fund acts as a feeder fund that collects money from domestic investors in India. The money is then passed on to the master fund, which is PGIM Jennison Global Equity Opportunities Fund. The fund manager of the master fund further invests the money in global companies like Tesla, Apple, etc. listed on the US stock exchanges.
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