Impact of FEMA Rules on NRI Mutual Fund Investments

Investing in Indian mutual funds is an excellent way for NRIs to grow wealth and diversify their portfolio. For this, NRIs need to follow the guidelines set by the Foreign Exchange Management Act 1999 (FEMA). However, navigating these rules can seem difficult. Additionally, violations can result in frozen accounts, penalties, and, in severe cases, legal action.

To help you understand the impact of FEMA rules on NRI mutual fund investments, this blog will provide guidance. It includes which account you should use, what you can and cannot do, how repatriation of funds works, and how to avoid paying penalties. In short, at the end of the blog, you will know by following the FEMA rules how to invest in mutual funds confidently.

FEMA Basics Every NRI Mutual Fund Investor Should Know

The full form of FEMA is the Foreign Exchange Management Act. This act was introduced by the government in 1999, replacing the FERA (Foreign Exchange Regulation Act). Compared to the old act, it has a more liberalized structure for managing foreign exchange in India. In simple words, FEMA is:

• How NRIs can send money in India
• Bank accounts they can use
• What they can invest in
• How NRIs can bring back money out (repatriation)

Further, as mentioned above, for NRIs investing in mutual funds, FEMA has designed a specific set of rules. Considering this, you cannot use any bank account or invest in any instruments. Additionally, you cannot transfer your money freely without following the requirements.

The primary objective of FEMA is to facilitate external payments and trade while maintaining the orderly development of the foreign exchange market of India. Under FEMA provisions, NRIs are allowed to invest in several financial instruments in India. It includes exchange-traded funds (ETFs), direct stocks, and mutual funds. 

However, following the FEMA regulations is vital, such as the submission of the Know Your Customer (KYC) updated documents, and compliance with repatriation limits. Additionally, opening a rupee-dominated Non-Resident External (NRE) or Non-Resident Ordinary (NRO) account.

So, this was all about FEMA basics that every NRI mutual fund investor should know. Moving ahead, let's know the FEMA rules for using NRE & NRO accounts in mutual funds.

FEMA Rules for Using NRE & NRO Accounts in Mutual Funds

FEMA allows NRIs to open three types of bank accounts, each of which serves a different purpose. Additionally, selecting the wrong one for mutual funds can later create issues.

NRE Account (Non-Resident External)

• What it is for: Managing foreign earnings, such as business, salary income earned overseas.
• FEMA Rules:
  • You can only credit your foreign currency earnings converted to INR. Additionally, make the transfers from other FCNR/NRE accounts.
  • Under this account, you cannot credit the income you earned in India, such as a pension, dividends, or rent. 
• Best for Mutual Funds: An NRE account is best for mutual funds when you are funding your investments with your foreign income. Additionally, you want to maximize the flexibility of repatriation.

NRO Account (Non-Resident Ordinary)

• What it is for: This account is for managing your Indian earnings, such as rental income, sale proceeds, pension, interest, or dividends.
• FEMA Rules:
  • An NRO account allows you to credit both your income, i.e., Indian and foreign.
  • For fund repatriation, you need a CA certificate (Form 15CB). Additionally, if the amount is more than INR 5,00,000, then you need to fill out Form 15CA.
• Best for Mutual Funds: This account is best for mutual funds when you are reinvesting your Indian income, like dividend or rental income. Additionally, when you do not have a plan to repatriate the large amounts.

FCNR Account (Foreign Currency Non-Resident)

• What it is for: This account is used for fixed deposits in foreign currency (USD, EUR, GBP, and more).
• Best for Mutual Funds: FCNR is best for mutual funds if you are redeeming them and want to do it in foreign currency before repatriation. For this, you need to transfer the balance of your NRE account to an FCNR fixed deposit account.

These were the rules for using NRE & NRO accounts in mutual funds. Selecting the correct account directly affects your documentation, repatriation flexibility, and taxation. This further makes the FEMA compliance vital for smooth investing. Now, moving ahead, let's know the FEMA repartition & rules for mutual fund redemption.

FEMA Repatriation Rules for Mutual Fund Redemption

Repatriation can be defined as the process of transferring money from India back to a foreign bank account. For repartition, as well, FEMA has strict rules on how much you can repatriate and under what circumstances.

• NRE Account Repatriation (Unlimited)
  • All redemption, including principal and gains, is repatriable without any limitations.
  • Beyond normal bank documentation, no need to file any form.
  • No need for special approvals.
  • Within 24-48 hours, funds are transferred to your foreign account.
• NRO Account Repartition ($1 Million Annual Limit)
  • Per financial year, i.e., April- March, you can repatriate up to $1 million.
  • Requires documentation: CA certificate (Form 15CB), Form 15CA filed online, if the amount is more than INR 5,00,000.
  • Across all types of NRO accounts and remittances, such as rental income, mutual funds, and more, this limit remains the same.
  • Process generally takes 7-15 days. 

Further, if you want to repatriate beyond $ 1 million, then FEMA allows you to take special approval from the RBI. It is granted in exceptional circumstances only, such as retirement process, inherited property, and more. However, approvals from the government take months, and it is not guaranteed that you will get it. 

These were the FEMA rules for fund repartition. Moving further, let's know about the permitted and restricted mutual fund investments under FEMA.

FEMA- Permitted and Restricted Mutual Fund Investments

Generally, FEMA allows NRI mutual fund investments. However, there are specific restrictions on it. Want to know about the permitted and restricted mutual funds for NRIs? Read the points below and get your answers:

This was all about permitted and restricted mutual fund investments for NRIs under the FEMA regulations. Moving ahead, let's know the mandatory KYC, FATCA & FEMA compliance requirements. 

Mandatory KYC, FATCA & FEMA Compliance Requirements

Under the FEMA regulations, NRIs must update their KYC details when their residential status changes. It is not an optional choice but a compliance requirement. Here is what you should do:

Step 1: From "Resident" to "NRI" Update KYC Status

Across all your mutual funds in India, through KRAs (KYC Registration Agencies) like KFintech and CAMs, your KYC is centralized. Considering this, when you get NRI status:

• Log in to KFintech KRA or CAMS KRA.
• Submit all the requested documents with updated information. It includes:
  • Copy of your passport (pages with name, address, photo, and visa stamps).
  • Work permit or visa from your current resident country.
  • PAN card
  • Proof of foreign address (tenancy contract, utility bill, bank statement)
  • Overseas bank account statement
• Complete in-person verification (IPV)
  • Visit an Indian consulate/ embassy in your country. Or
  • Submit apostilled/ notarized documents

Once you update your KYC information with one Asset Management Company (AMC), it automatically shows in all mutual funds you hold. This process generally takes 2-4 weeks. 

Step 2: File FATCA/ CRS Declaration

FATCA, or the Foreign Account Tax Compliance Act, and CRS, or the Common Reporting Standard, are international tax compliance structures. Under it, with 100+ countries, agreements have been signed by India to share financial information. Considering this, when investing in mutual funds, you should declare:

• Your tax residency country
• Tax Identification Number (TIN) in your resident country
• If you are a US person, special rules may apply to you

This information is used by AMCs to report your holdings to Indian tax officials, which is further shared with your home country. Further, without a CRS/ FATCA declaration, AMCs do not accept your investment. 

Step 3: Link NRE/NRO Account to Mutual Fund Folios

Once your Indian savings account is converted to an NRE/ NRO account, you should update this linkage with your every mutual fund folio. Several AMCs allow online account updates. You can do this by following the mentioned steps:

• Using your credentials, log in to the AMC platform or website.
• Visit "Profile" → "Bank Account Details".
• Add your NRE/ NRO account
• Complete verification. To verify your ownership, AMC will deposit Rs 1 to your account.

Further, now your redemptions will be credited to your NRE/ NRO account, maintaining FEMA compliance. It is advisable after gaining the NRI status, complete these three steps within 90 days. It is because the longer you delay the process, the higher the risk of frozen transactions or non-compliance penalties.

Now, moving further, let's know about the penalties for FEMA violations.

FEMA Violations in Mutual Funds and Their Penalties

FEMA violations in mutual funds can result in paying significant penalties. The Enforcement Directorate (ED) actively monitors and enforces FEMA regulations. Further, common FEMA violations include:

• Continuing to use a resident savings account after becoming an NRI. 
• Exceeding the NRO repatriation limit.
• Missing documentation for transactions such as Form 15CA/ 15CB.
• Investing in prohibited instruments.

These were the FEMA violations. Now, let's know the penalties included in it:

• INR 5,000 per day for continuing FEMA violations.
• Up to three times the amount included in quantifiable violations.
• Maximum of INR 2,00,000 for non-quantifiable violations. 

This was all about FEMA violations in mutual funds and their penalties. Moving ahead, let's know the role of FEMA in Taxation of NRI mutual fund gains. 

Role of FEMA in Taxation of NRI Mutual Fund Gains

Many NRIs often get confused between the FEMA and Indian tax laws. They are different, but they intersect. FEMA manages your foreign exchange transaction, such as which account you hold, repatriation limit, and more. Whereas, the Income Tax Act manages how you will be taxed on interest, capital gains, dividends, and more. Further, as an NRI, both are imposed on you. Here is how they interact for mutual fund gains:

Capital Gains Tax 

It is taxes according to the Income Tax Act when you redeem your mutual funds:

• Short-term capital gains (equity, held for less than 12 months): 15% tax.
• Long-term capital gains (equity, held for more than 12 months): 12.5% on gains more than INR 1,25,000.
• Short-term capital gains (debt, held for less than 24 months): taxed according to your slab rate.
• Long-term capital gains (debt, held for more than 24 months): 12.5% without indexation.

Further, AMC automatically deducts TDS (Tax Deducted at Source). If you file ITR, you can claim the refunds for your TDS. 

Repatriation and Tax Clearance (FEMA + Tax Laws)

When you repatriate your mutual funds through an NRO account:

• FEMA requires funding source proof
• Income tax law requires submission of Form 15CA and Form 15CB (CA certificate confirming the paid taxes)
• The bank verifies both before remittance processing. 

In case the taxes are not paid and TDS is not deducted, until you clear all your tax dues, the bank will not allow repatriation. 

DTAA Benefits (Tax Law, but Impacts FEMA Repatriation)

India has signed Double Taxation Avoidance Agreements (DTAA) with 90 countries. So if you paid taxes on your mutual fund gains in India and your resident country, you can claim a tax credit in one country for your paid taxes in the other. Further, it does not change the repatriation limit of FEMA, but it impacts how much you keep after taxes. 

Additionally, there is a myth that NRE investments are tax-free. The truth is that only the interest you earn on NRE deposits is tax-free. Considering this, whether you invested through NRE or NRO, identically, mutual fund gains are taxed. So, not saving tax on capital gains, the benefit of NRE is unlimited repatriation of funds. 

Final Thoughts

Lastly, understanding the FEMA rules on NRI mutual fund investments is vital if you want to confidently manage your Indian finances. When you follow FEMA rules, you are not only avoiding penalties, but you are also ensuring that your investments are legal, safe, and completely yours.

Further, if you still have any confusion with FEMA rules on NRI mutual fund investments or need help in opening an NRE/ NRO account, connect with Savetaxs. We have a team of tax professionals to help you solve all your doubts and assist you in opening your NRE bank account.