India HNIs face new hurdle post Musk-linked jackpot

Many Indians with SpaceX shares are facing new obstacles in preserving their wealth after they made significant investments through unregulated funds. The recent in-specie distribution of SpaceX shares to investors has raised concerns about regulatory compliance. Previously, these investors had purchased unlisted shares through offshore funds under the liberalized remittance scheme (LRS), which allows a resident individual to spend and invest up to $250,000 a year overseas, subject to certain conditions.

The distribution of SpaceX shares in exchange for unlisted units aims to avoid stock dumping and defer taxes for investors. However, the receipt of listed shares may pose regulatory hurdles, as the RBI has not approved it. Vishal Gada, founder and CEO of Aurtus, states that the in-specie distribution should not require prior RBI approval, as the investor had no legal or operational control over the distribution or liquidation process.

Under the LRS, swapping one asset for another, such as units for shares, is permissible in mergers and acquisitions or liquidation scenarios. However, the RBI may view the in-specie distribution as a genuine liquidation if the fund set up to hold a stock is dismantled soon after the listing. Harshal Bhuta, a partner at CA firm P. R. Bhuta & Co., explains that the reinvestment rule requires sale proceeds to be invested within six months, but there's no forex realization in the case of in-specie distribution, which could affect the taxpayer's obligation to liquidate the SpaceX shares received in exchange for the units.

The mode of reinvestment also plays a crucial role in determining regulatory compliance. The terms of the fund and its implementation will determine whether the receipt of SpaceX shares qualifies as capital gains or not. Furthermore, investors who disclosed their unlisted units as Overseas Portfolio Investments (OPI) instead of Overseas Direct Investments (ODI) between August 2022 and June 2024 might face regulatory issues.

The RBI’s June 2024 amendment to the ODI framework allows portfolio investments in funds regulated through their managers, covering jurisdictions like Singapore, which might affect those who entered the market through unregulated structures before this amendment. The tax implications remain uncertain, with some tax experts believing that there would be no tax until the shares are sold, while others argue that the fund units could be regarded as transferred, with fair market value of the underlying listed shares treated as consideration received, potentially subjecting the investor to capital gains tax in India.