U.S. Tax Implications for Indian Startup Equity Abroad

(INDIA) India’s 2025 tax bill has introduced a change that is drawing close attention from U.S. citizens who hold Indian startup equity. A new clause, described as Clause 72(6) in the Income Tax Bill 2025, allows many Non-Resident Indians to compute capital gains on sales of unlisted Indian shares in the same foreign currency they used to buy those shares. Officials say the aim is to reduce the pain from currency swings, which often increased Indian tax when the rupee fell against the dollar. For Americans with Indian startup stakes, and for Indian-origin professionals with shares from early-stage companies, the reform could reduce Indian-side tax on long-term exits and reshape cross-border taxation planning for the next wave of startup growth.

Why this change matters

Many Indian startups remain unlisted, and employees, founders, and early backers often live abroad. Because the United States taxes citizens on worldwide income, U.S. citizens who receive options, restricted stock units (RSUs), or direct shares in an Indian company must still report gains under U.S. rules.

The new Indian clause does not change U.S. tax rules. Instead, it changes the Indian side of the equation and therefore affects:

• How much foreign tax credit may be available in the U.S.
• How much cash a person needs to set aside for taxes in India and the U.S.
• Overall cross-border tax planning and timing considerations

U.S. tax basics for foreign equity

Under U.S. rules, equity from a foreign company can trigger tax events at different times:

• Ordinary income can arise when options are exercised or RSUs vest (depending on award terms).
• Capital gains arise when shares are sold:
  • Short-term gains taxed at ordinary rates.
  • Long-term gains typically taxed at 15% or 20%, depending on income.
• U.S. tax calculations must be done in dollars and reported on federal returns.

Key forms and references:
– Main return: Form 1040 — see: IRS page for Form 1040
– Stock sale reporting: Schedule D and Form 8949 — see: About Schedule D (Form 1040) and About Form 8949
– Foreign bank reporting (FBAR, FinCEN): Report of Foreign Bank and Financial Accounts (FBAR)
– PFIC considerations: Form 8621 — see: About Form 8621

Note: If the foreign company qualifies as a Passive Foreign Investment Company (PFIC), special paperwork and often harsher tax treatment may apply.

How India taxed these gains before — and what’s changing

Historically, India taxed capital gains from Indian shares by converting both the cost and sale proceeds into rupees. When the rupee weakened, rupee-denominated gains could grow even if the investor’s dollar gain was small, increasing the Indian tax bill.

Clause 72(6) changes that for unlisted shares by allowing NRIs to compute gains in the original foreign currency (e.g., dollars). This aligns the Indian capital gains calculation more closely with the investor’s actual currency outcome, removing distortions from exchange-rate swings.

Practical effects at exit

If an employee or angel investor sells unlisted shares and qualifies under Clause 72(6):

• Indian tax due could be lower (especially when rupee has weakened).
• U.S. foreign tax credit (claimed on Form 1116) may likewise be lower — see: About Form 1116
• The net result is a shift of tax between jurisdictions, not necessarily a global reduction.

Important mechanics:
– U.S. foreign tax credits are subject to caps and income baskets, so timing, exchange rates, and PFIC status can change allowed credit amounts.

Treaty context

The U.S.–India tax treaty (Convention Between the United States of America and the Republic of India for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income) provides baseline rules on taxing rights and double-tax relief.

• U.S. treaty resources: India Tax Treaty Documents
• The treaty reduces friction but does not eliminate U.S. citizenship-based taxation.
• Practically, compute Indian tax first, then typically claim a U.S. foreign tax credit.

Pre-exit events, withholding, repatriation, and records

Equity often triggers taxable events before exit:

• Vesting/exercise events can create Indian tax liabilities (for residents) and U.S. taxable compensation.
• NRIs may face withholding or tax deduction at source on share sales in India.
• Repatriation of proceeds requires compliance with RBI norms and bank procedures; approvals and documentation can take time.

Documents to keep:
– Allotment letters, option grant documents, exercise notices
– Contract notes, bank records, cap table reports
– Proof of Indian tax paid and any withholding certificates

These records support both Indian filings and U.S. return positions.

PFIC risk — a major U.S.-side concern

PFIC rules are a significant risk for U.S. citizens who hold foreign startups:

• PFIC test examines passive income and passive assets.
• If a foreign startup qualifies as a PFIC, U.S. tax can be higher via mark-to-market or “excess distribution” regimes.
• PFIC treatment can apply even before a sale, sometimes removing long-term capital gain treatment.
• Missing Form 8621 can cause severe consequences, including adverse default tax treatments.

Key action: early PFIC analysis and detailed record-keeping. Tax advisers often recommend early elections when advantageous.

Who benefits and who may not

• Beneficiaries:
  • NRIs and U.S. citizens who invested in unlisted Indian startups and paid in foreign currency may see fairer Indian capital gains.
  • Founders recruiting abroad can offer equity without forcing foreign staff to shoulder currency-driven Indian tax increases.
• Those who may not benefit as much:
  • Investors subject to PFIC rules — they could still face heavier U.S. tax.
  • Holders with short holding periods or high ordinary U.S. income — net effects may vary.

Timing and location matter: where you are at key dates (grant, vesting, sale) can change tax outcomes in both countries.

Employer and plan design implications

Startups and founders should consider U.S. rules when structuring grants:

• Equity to Americans (including H‑1B holders) can raise U.S. payroll/reporting implications.
• Contracts increasingly:
  • Spell out vesting schedules and exercise windows
  • Note buyback rights and tax triggers
  • Provide for cooperation on tax forms with foreign holders

With Clause 72(6), term sheets and equity agreements may also call out foreign-currency computation at exit and PFIC risk disclosures.

Holding periods and tax rates

Holding period differences influence rates in both countries:

• U.S.: >1 year generally yields long-term capital gains.
• India (unlisted shares): commonly 2 years for long-term treatment.

If either threshold isn’t met, higher rates apply and foreign tax credit math can be affected. Credits are often split across different baskets on Form 1116, limiting usable credits in some years.

Reporting obligations — don’t skip forms

Common U.S. filings for these taxpayers:
– Schedule D and Form 8949 — capital gains reporting
– Form 8621 — PFIC reporting
– FBAR — FinCEN filing for foreign accounts meeting thresholds
– Form 1116 — foreign tax credit calculations

Indian obligations:
– File Indian return if non-resident income arises in India
– Use documentation to claim refunds when tax was withheld in excess

Missing or late filings can block credits and cause penalties.

Bank and remittance procedures

After a sale, NRIs moving funds abroad must follow Reserve Bank and bank procedures:

• Banks will request proof of tax clearance and source of funds.
• Equity proceeds fall under foreign exchange controls and may require supporting documents.
• Matching tax returns with remittances reduces friction and speeds transfers.

Broader market and policy effects

Industry and market impacts:

• The change is seen as a nod to diaspora participation and may encourage more foreign small investors and early workers to back Indian startups.
• It could reduce the tax drag from rupee depreciation on long-dated exits.
• Startups and advisers will watch for guidance on edge cases (convertible notes, secondary transfers, etc.).

VisaVerge.com analysis suggests:
– Term sheets may explicitly reference potential foreign-currency computation and PFIC considerations.
– Companies may provide annual cap table reports to help foreign holders prepare U.S. filings.

Practical planning advice

• Keep meticulous records of grants, dates, fair market values, and tax paid.
• Budget for U.S. tax at vest/exercise even if no sale occurs yet.
• Check PFIC status early and consider elections with advisers.
• Coordinate filings in both countries and maintain bank paperwork for remittances.
• For students and early-career workers: small shares may produce surprise taxable events later — track everything.

Key takeaway: Clause 72(6) reduces one form of unfairness caused by currency swings by allowing computation in the investor’s original foreign currency for unlisted shares, but it does not eliminate PFIC risk, timing mismatches, or cross-border filing complexity.

What to watch next

• Official guidance from Indian tax authorities on Clause 72(6) specifics and edge cases.
• How banks apply remittance and clearance procedures to equity proceeds.
• Whether startups and term sheets evolve to give foreign holders clearer data and tax cooperation.
• Ongoing interaction with PFIC rules and whether U.S. advisers change filing strategies.

For cross-border workers and small investors, the overarching advice is simple: stay alert, keep records, plan early, and consult advisers on PFIC status and withholding so you avoid last-minute surprises. The 2025 change does not solve every issue around Indian startup equity for Americans, but it removes one major source of currency-driven tax pain and makes holding and exiting unlisted Indian equity fairer for many.