Taxation of Mutual Funds for NRIs in India 

28 September 2023
6 min read
Taxation of Mutual Funds for NRIs in India 
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Mutual funds have long been a popular investment avenue due to their potential for wealth creation and diversification benefits. However, NRIs investing in mutual funds need to navigate through a specific set of tax regulations and provisions that apply to them.

Understanding the intricacies of NRI taxation of mutual funds is vital to optimising returns and complying with the tax laws of the home country and India.

In this blog, we will delve into the nuances of NRI taxation of mutual funds, providing insights and guidance to help NRIs make informed investment decisions and ensure tax compliance.

Synopsis

NRIs can invest in Indian Mutual Funds following Foreign Exchange Management Act (FEMA) regulations. They need to set up an NRE (Non-resident External) or NRO (Non-resident Ordinary) account. After this, they must comply with KYC regulations. With an active bank account and completed KYC, NRIs can proceed to invest in Mutual Funds in India.

Some Mutual Fund houses may impose restrictions on NRIs from the USA and Canada due to compliance obligations related to the Foreign Account Tax Compliance Act (FATCA). However, some fund houses permit these NRIs to invest under specific conditions and via offline transactions.

NRIs can also benefit from potential currency appreciation, resulting in increased profits when the rupee value appreciates against their resident country's currency.

Tax Implications

NRIs investing in mutual funds in India need to consider the following tax implications:

  • Tax Deducted at Source (TDS) 

NRIs are subject to Tax Deducted at Source (TDS) when redeeming mutual funds, with the specific TDS rate determined by the scheme type (equity or non-equity) and the duration of holding the funds.

  • Short-term Capital Gains - Profits earned from the sale of a mutual fund with a holding period of one year or less.

  • Long-term Capital Gains - Profits earned from the sale of a mutual fund with a holding period of more than one year.

Particulars

TDS on Short-term Capital Gains

TDS on Long-term Capital Gains

TDS on Distributed Income under IDCW Option

Equity Mutual Funds

15%

10%

20%

Other than Equity Oriented Fund

30%

Listed - 20% with indexation

Unlisted - 10% without indexation

20%

The TDS is charged at the highest applicable rate. If the NRI falls in a lower tax slab, they are eligible for a refund when filing their returns.

  • Capital Gains Tax

The tax rate for capital gains on mutual funds depends on the type of scheme and the holding period.

Particulars

Tax on Short-term Capital Gains

Tax on Long-term Capital Gains

Equity Mutual Funds

15%

Gains exceeding Rs. 1 lakh - 10% without indexation benefit

Other than Equity Oriented Fund

Taxed based on the income tax bracket

Listed - 20% with indexation

Unlisted - 10% without indexation

NRIs paying higher TDS than their lower tax slab can claim a refund when filing taxes. TDS deducts income tax at the highest rate initially; so if an NRI's tax slab is lower, they can reclaim the extra tax through refunds.

  • Tax Return of Income

NRIs are not required to file a return of income if their total income consists only of investment income or long-term capital gains with appropriate TDS deductions. 

Filing returns in India also has its benefits. If your income falls in a lower tax slab, you are eligible for a refund on the TDS deduction when filing returns.

  • Taxation of Dividends

Dividend received from dividend schemes - equity as well as non-equity will be considered as income of the year and will be taxed as per the applicable tax slab rate. 

Tax Benefits 

Here are some of the key tax benefits an NRI can avail when investing in Mutual Funds -

1) Double Taxation Avoidance Agreement (DTAA)

  • DTAA is a treaty signed between two countries to prevent double taxation of the same income for residents. Under DTAA, gains from investments in India are taxed only in one country, depending on the terms of the agreement.
  • NRIs can claim the benefit of taxes and TDS deducted in India against their tax liability in their country of residence.
  • This deduction can be claimed by providing certain documents to the deductor, which can include a self-declaration cum indemnity format and a copy of citizenship/ PIO Proof. 

Visit https://incometaxindia.gov.in/pages/international-taxation/dtaa.aspx for more information.

2) Section 80C Deduction

  • By investing in ELSS or Equity Linked Saving Schemes, tax benefits can be availed of under Section 80C, up to Rs 1,50,000.

Key Terms to Remember About Mutual Funds Taxation for NRIs

Here are some of the significant terminologies to take a note of-

  • Capital Gains Tax -  Capital Gains Tax is a tax levied on the profit earned from selling certain assets like property or investments. It is categorised into Long-Term Capital Gains (LTCG) or Short-Term Capital Gains (STCG) based on the holding period.
  • TDS  - TDS is a mechanism in which the payer deducts a certain percentage of tax from the payment made to the recipient. It is submitted to the government on behalf of the recipient to ensure tax compliance and revenue collection.
  • LTCG - This refers to the profit obtained from the sale of certain assets held for a specified period. The holding period varies with the asset. It is subject to a different tax rate and benefits like indexation, depending on the asset type.
  • STCG - It pertains to the profit gained from the sale of assets held for a short duration. It is taxed at a different rate compared to long-term gains.
  • Indexation - Indexation is a technique used to adjust the cost of acquiring an asset for inflation. It helps reduce the tax burden on long-term capital gains by considering the effect of inflation on the asset's original purchase price.
  • IDCW - IDCW (Income Distribution Cum Capital Withdrawal) is a dividend payout option in mutual funds where unitholders receive both investment profits (also known as income distribution) and and some of their invested money back at regular intervals.
  • Equity Oriented Funds -  These are mutual funds or funds that predominantly invest in equity shares of companies.

  • Non-Equity Oriented Funds - These funds are mutual funds that primarily invest in assets other than equities, such as debt instruments.

Conclusion

Understanding the taxation of mutual funds for NRIs in India is crucial for making informed investment decisions and ensuring compliance with tax laws.

It is important to stay updated on the provisions and benefits of the DTAA to optimise investment returns and fulfil tax obligations effectively.

Knowledge of the tax implications makes it possible to navigate the investment landscape with confidence and maximise financial outcomes.

You can also refer to AMFI (Association of Mutual Funds in India) guidelines on Mutual Fund Taxation : https://www.amfiindia.com/investor-corner/knowledge-center/tax-corner.html.

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