Mutual Fund Taxation for NRIs

Understanding how Mutual Fund taxation works for Non-Resident Indians (NRIs) can be tricky as they face the possibility of double taxation when they earn abroad but invest in India. Thankfully, Double Taxation Avoidance Agreements (DTAA) offer a solution to minimize taxes for NRIs.

Let’s explore how NRIs can use DTAA to make their investment journey smoother and more tax-efficient.

Taxation of Mutual Funds for NRIs:

When NRIs invest in Mutual Funds in India, they are subject to certain tax implications. Here’s a breakdown:

Capital Gains Tax-

• Equity Mutual Funds: If an NRI sells equity mutual funds after holding them for more than one year, the gains are considered long-term capital gains (LTCG). As of the current tax laws, LTCG on equity funds is taxed at 10% if gains exceed Rs. 1 lakh in a financial year.
• Debt Mutual Funds: For debt mutual funds, if held for more than three years, the gains are also treated as long-term capital gains. LTCG on debt funds is taxed at 20% with indexation benefits, which adjusts the purchase price for inflation.

If you hold residency in one country but earn income in another, the Income Tax Act of 1961 requires you to pay taxes on your earnings. This could potentially lead to double taxation, paying taxes in both your home country and the one where you earn income. To address this issue, the Fiscal Committee of the League of Nations introduced DTAA in 1927 to avoid the unfairness of double taxation on the same income.

Double Taxation Avoidance Agreements (DTAA)

A Double Taxation Avoidance Agreement (DTAA) is a treaty signed between two countries to prevent individuals from being taxed on the same income in both countries. DTAA covers individuals residing in one country and generating income in another country. It outlines which income will be taxed in India and which will be taxed in the foreign country. Some foreign countries do not impose capital gains tax.

Under DTAA, India has signed agreements with 85 countries, including popular NRI destinations like the USA, UK, UAE, Singapore, and others. According to these agreements, gains from Mutual Fund investments in countries such as the USA, Australia, UK, and China are subject to taxation in India. On the other hand, gains from investments in Kuwait, Qatar, Netherlands, Luxembourg, Cyprus, Saudi Arabia, Japan, including Malaysia, are taxed in their respective countries. Countries like UAE, Oman, Singapore, and Mauritius impose zero tax on these gains.

To benefit from DTAA, three conditions must be fulfilled as follows: 

• The individual must be designated as a Non-Resident. 
• They need to obtain a tax residency certificate from the appropriate foreign tax authorities.
•  It is essential to submit Form 10F on the income tax portal to access the DTAA benefits.

Impact of DTAA on NRI Mutual Fund Taxation

Under DTAA, NRIs can claim relief from double taxation. For instance, some DTAA agreements specify lower tax rates for capital gains on equity investments, bringing down the tax burden for NRIs. Here’s how it generally works:

• Reduced Withholding Tax- For NRIs, the most significant impact of DTAA is on the withholding tax rates. When NRIs redeem mutual funds, the fund house deducts tax at Source (TDS) on the gains. Under DTAA, the tax rates are often reduced compared to the standard rates. For example, if the standard rate of TDS is 10%, DTAA might reduce it to 5% or even lower.

• Exemption or Reduction in Capital Gains Tax- DTAA may also provide exemptions or reductions in capital gains tax. This can depend on the type of mutual fund and the country of residence of the NRI.

Example: Let’s consider an NRI residing in the USA who invested in Indian mutual funds:

• Without DTAA: The NRI would be subject to the standard tax rates in India, and any gains would be taxed at the prevailing rates.
• With DTAA: If the DTAA between India and the USA specifies a lower tax rate for capital gains, the NRI can benefit from this reduced rate, resulting in lower taxes on their mutual fund gains.

It’s crucial for NRIs to consult with tax advisors or financial experts familiar with both Indian tax laws and the DTAA provisions to ensure they optimize their investments and minimize tax liabilities.