Mutual funds are a popular investment option for Non-Resident Indians (NRIs) who want to invest in India. However, NRIs need to be aware of the tax implications of investing in mutual funds in India. In this article, we will discuss the various tax implications of mutual funds for NRIs.
Understand taxation of mutual funds for NRIs in India
Non-Resident Indians (NRIs) can engage in Indian Mutual Funds under the regulations outlined by the Foreign Exchange Management Act (FEMA). They are required to establish either an NRE (Non-resident External) or NRO (Non-resident Ordinary) account and adhere to KYC regulations. Once these steps are completed and they possess an active bank account and fulfilled KYC requirements, NRIs can proceed to invest in Indian Mutual Funds.
Certain Mutual Fund houses may impose restrictions on NRIs from the USA and Canada due to compliance obligations associated with the Foreign Account Tax Compliance Act (FATCA). However, some fund houses allow these NRIs to invest under specific conditions and via offline transactions.
Additionally, NRIs stand to benefit from potential currency appreciation, leading to increased profits if the rupee value appreciates against the currency of their resident country.
- Capital gains tax: Capital gains tax is the tax levied on the profit earned from the sale of mutual fund units. For NRIs, capital gains tax is applicable on both equity-oriented and non-equity-oriented funds. The tax rate for LTCG on equity-oriented funds is 10% without indexation benefits over and above the overall exemption limit of Rs. 1 lakh. For STCG on equity-oriented funds, the tax rate is 15%. For non-equity-oriented funds, LTCG is applicable at 20% of the gains with the benefit of indexation, if the investment is held for more than three years. For non-equity mutual funds with less than 35% equity holdings in their overall portfolio, any gains on investment on or after April 1, 2023, and a holding period of less than three years will be classified as STCG, added to the total income of the taxpayer, and taxed as per the income tax slab rate applicable.
- Tax deducted at source (TDS): TDS is applicable on capital gains. For NRIs, TDS is deducted at the time of redemption of mutual fund units. The rate of TDS depends on the type of mutual fund and the duration of the investment. For equity-oriented funds, the TDS rate is 10% for long-term capital gains (LTCG) and 15% for short-term capital gains (STCG). For non-equity-oriented funds, the TDS rate is 20% with indexation for LTCG for listed schemes and 10% without indexation for unlisted schemes and as per the income tax slab rate (at 30% assuming that the investor falls under the highest tax slab) for STCG.
- Tax return of income: NRIs are required to file their tax returns in India Even if the income does not exceed the basic exemption limit, NRIs have to file tax returns in case the investor wants to claim tax refund of the TDS on capital gains.. The basic exemption limit for NRIs is Rs. 2.5 lakh. NRIs can file their tax returns online or offline.
- Taxation of dividends: Dividends received from mutual funds are taxed in the hands of the investor. TDS on dividend income for NRI is 20% (excluding cess and surcharge).
- Tax benefits: NRIs can avail of tax benefits under Section 80C of the Income Tax Act, 1961, by investing in mutual funds. The maximum deduction allowed under Section 80C is Rs. 1.5 lakh. NRIs can also avail of tax benefits under the Double Taxation Avoidance Agreement (DTAA) between India and their country of residence.
- Double Taxation Avoidance Agreement (DTAA): DTAA is an agreement between two countries to avoid double taxation of the same income. NRIs can avail of the benefits of DTAA by claiming tax credits in their country of residence for the taxes paid in India.
Essential concepts in mutual funds taxation for Non-Resident Indians
- Capital Gains Tax: Capital gains tax is the tax levied on the profit earned from the sale of mutual fund units.
- TDS: TDS is a tax that is deducted at the source of income.
- LTCG: LTCG is the profit earned from the sale of mutual fund units held for more than one year in case of equity-oriented scheme and 3 years in case of non equity-oriented schemes.
- STCG: STCG is the profit earned from the sale of mutual fund units held for less than one year in case of equity-oriented scheme and 3 years in case of non equity-oriented schemes.
- Indexation: Indexation is a technique used to adjust the purchase price of an asset for inflation.
- IDCW: IDCW stands for Income Distribution Cum withdrawal.
- Equity Oriented Funds: Equity-oriented funds are mutual funds that invest at least 65% of their assets in equity shares of domestic companies.
- Non-Equity Oriented Funds: Non-equity-oriented funds are mutual funds that invest less than 65% of their assets in equity shares of domestic companies.
Tax benefits of Mutual Funds for NRI Investors
Here are the primary tax advantages accessible to NRIs when investing in Mutual Funds:
Double Taxation Avoidance Agreement (DTAA)
- DTAA is an agreement between two nations aimed at preventing double taxation of the same income for residents. Under DTAA, gains from investments in India are taxed solely in one country, based on the agreement's terms.
- NRIs can offset taxes and TDS deducted in India against their tax liability in their country of residence.
- To claim this deduction, NRIs must furnish specific documents to the deductor, including a self-declaration cum indemnity format and proof of citizenship/PIO. Visit the Income Tax India website for more details on DTAA.
Section 80C Deduction
- Investing in ELSS or Equity Linked Saving Schemes allows individuals to claim tax benefits under Section 80C, up to Rs 1,50,000.
How NRIs can invest in mutual funds
- Self or direct method: NRIs can invest in mutual funds in India through the self or direct method. They can invest in mutual funds online or offline by opening an NRE or NRO account with a bank in India. They can also invest in mutual funds through the Portfolio Investment Scheme (PIS) route.
- Power of attorney method: NRIs can also invest in mutual funds in India through the power of attorney method. They can appoint a resident Indian as their power of attorney holder to invest in mutual funds on their behalf.
Regulations on mutual fund investments for NRIs
- KYC: NRIs are required to complete the Know Your Customer (KYC) process before investing in mutual funds in India. The KYC process involves submitting identity proof, address proof, and other relevant documents.
- Remittance certificate: NRIs are required to obtain a remittance certificate from a chartered accountant (CA) to prove that the funds invested in mutual funds were remitted from abroad.
- Redemption: NRIs can redeem their mutual fund units in India and the redemption proceeds can be credited to their NRE or NRO account. The redemption proceeds can also be remitted abroad after deducting taxes.
In conclusion, understanding the taxation of mutual funds for NRI investors in India is crucial for informed financial decisions. Navigating through the complexities of tax regulations, including the Double Taxation Avoidance Agreement (DTAA) and Section 80C deductions, empowers NRIs to optimise their investment strategies and minimise tax liabilities.
By leveraging available tax benefits and adhering to regulatory requirements, NRIs can enhance the efficiency and effectiveness of their mutual fund investments in India. Ultimately, staying informed about the tax implications ensures that NRI investors can make prudent investment decisions aligned with their financial goals and objectives while maximising returns and minimizing tax burdens.
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