Introduction
Investing in mutual funds is a popular option for Non-Resident Indians (NRIs) looking to diversify their investment portfolio in India. Understanding the tax implications associated with mutual fund investments is crucial, as it significantly impacts overall returns. This guide will delve into the details of mutual fund taxation for NRIs, covering aspects such as capital gains tax, dividend distribution tax (DDT), tax residency certificate (TRC), and other key points.
1. Capital Gains Tax
Gains from selling mutual fund units are subject to capital gains tax, with the treatment depending on the holding period.
Short-term Capital Gains (STCG)
If an NRI holds mutual fund units for up to 3 years, the gains are treated as STCG and taxed based on applicable income tax slab rates in India. These gains are added to the NRI's total income and taxed at rates ranging from 0% to 30%, depending on the income slab.
Long-term Capital Gains (LTCG)
If the holding period exceeds 3 years, gains are treated as LTCG. For equity-oriented mutual funds (with over 65% allocation to equities), authorities impose a flat 10% tax without indexation if gains exceed INR 1 lakh in a financial year, and the gains exceeding that will be taxed at 10%. For debt-oriented mutual funds (with less than 65% allocation to equities), LTCG is taxed at 20%, with indexation benefits.
2. Dividend Distribution Tax (DDT)
DDT is a tax levied by mutual fund companies on distributed dividends, and its treatment for NRIs has evolved.
Equity-oriented Mutual Funds
Dividends paid by equity-oriented mutual funds to NRIs were subject to Dividend Distribution Tax (DDT) at the rate of 10%, plus an additional surcharge and health and education cess, before distributing them to the NRI investors. Since April 1, 2020, mutual fund companies aren't liable for DDT on dividends for NRIs. Instead, dividends are taxable in the hands of investors based on their applicable income tax slab rates in India, ranging from 0% to 30%.
Debt-oriented Mutual Funds
Similar to equity-oriented funds, DDT doesn't apply, and dividends are taxable in the hands of NRIs based on their income slab rates.
3. Tax Residency Certificate (TRC)
To avoid double taxation, NRIs can utilise the Double Taxation Avoidance Agreement (DTAA) between India and their country of residence. Obtaining a Tax Residency Certificate (TRC) is essential, serving as proof of residency and determining taxability based on the tax treaty between the two countries.
4. Other Important Points
Tax Implications on Switching or Redemption
Switching or redeeming mutual funds triggers capital gains tax implications, and NRIs must consider these implications when making such transactions.
TDS (Tax Deducted at Source)
Mutual fund companies must deduct TDS on capital gains earned by NRIs during redemption. The rates are 20% for LTCG and 15% for STCG, varying based on the mutual fund type and applicable tax treaty. Excess TDS can be claimed as a refund when filing income tax returns.
Reporting in Income Tax Returns
NRIs must report mutual fund investments in their income tax returns in India, providing details of units held, capital gains earned, and taxes paid or deducted.
Tax Implications on Systematic Investment Plans (SIPs)
Each SIP instalment is considered a distinct investment with its own holding term for capital gains tax calculations. NRIs should be aware of the implications based on the holding period of each SIP instalment.
Conclusion
NRIs investing in mutual funds in India must understand the tax implications to make informed decisions. Knowledge of capital gains tax, dividend distribution tax, obtaining TRC when necessary, and awareness of TDS and reporting requirements are crucial. Seeking professional tax advice and staying updated with the latest tax laws can help NRIs optimise their tax liabilities on mutual fund investments in India.
The author is a Chartered Accountant and former EY employee, serves as the Chief Consultant of the NRI Desk and Influencer Desk at AKT Associates. He specialises in offering consultancy services tailored for NRIs and is dedicated to creating educational content to raise awareness within the NRI community.
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