How are NRIs Taxed on Mutual Fund Gains?

Investing in mutual funds can be a profitable route for Non-Resident Indians (NRIs) looking to grow their wealth while maintaining ties to the Indian financial market. A mutual fund collects money from many investors to invest in various assets like stocks, bonds, and other financial products. 

An NRI can invest in mutual funds in India through an NRE (Non-Resident External) and NRO (Non-Resident Ordinary) account. They need an active bank account and a completed KYC to proceed further with NRI investing in mutual funds in India.

NRIs are subject to specific tax rates on gains from Indian mutual funds, which may vary depending on the type of fund and holding period. Additionally, the TDS (Tax Deducted at Source) is mandatory on redemptions for NRIs. 

In this blog, we will help you understand how NRIs are taxed on mutual fund gains and the steps to get started with this investment option. 

What are Mutual Fund Gains for NRIs?

A mutual fund is a collection of money that collects money from many investors and invests in several bonds, stocks, assets, and other money market instruments. It is managed by a professional fund manager who makes the decisions related to investment based on the fund's objectives. The investment made in a mutual fund is not a single share but several shares. It might not necessarily be shares and could be either bonds or other securities as well.

An NRI can also invest in a mutual fund, for which they need to open an NRE (Non-Resident External), an NRO (Non-Resident Ordinary), or an FCNR (Foreign Currency Non-Resident) account.

Additionally, NRIs from the US and Canada may face some restrictions from mutual fund houses due to compliance obligations related to the FATCA (Foreign Account Tax Compliance Act).

How are Equity Mutual Fund Gains Taxed for NRIs?

A mutual fund investment scheme must invest at least 65% of its portfolio in domestic equities to be classified as an equity fund. Here is how equity mutual funds will be taxable for NRIs:

• Short-Term Capital Gains: STCG (Short-Term Capital Gains) held for less than 12 months are taxed at a flat rate of 20%.
• Long-Term Capital Gains: For investments held longer than 12 months and gains exceeding the exemption threshold (Rs. 1.25 lakh annually)are now taxed at a rate of 12.5%, without indexation benefits.
• STT: Securities Transaction Tax (STT) of 0.001% is also applicable.
• ELSS (Equity-Linked Savings Scheme): The funds held in an ELSS also follow the same tax rules and have a lock-in period of three years.

How are Debt Mutual Fund Gains Taxable for NRIs?

Your overall taxable income also includes capital gains from mutual funds. These are taxed as per your applicable income tax slab rate. Debt mutual funds are those that have less than 35% equity exposure. Here is how it is taxed:

• Short-Term Capital Gains: Short-term capital gains for holding of less than 36 months are taxed at the individual's slab rate.
• Long-Term Capital Gains: A tax rate of 20% is applicable for long-term capital gains for holdings of 36 months or more, along with indexation for investments made before July 2025, and 12.5% without indexation after that.
• TDS Deduction: Under the 2025 budget, an exemption of Rs. 4 lakh every year is introduced. Additionally, resident investors do not face any TDS deduction.
• Indexation Perk: For investments made after April 1, 2023, there are no indexation benefits.

How are Hybrid Mutual Fund Gains Taxed for NRIs?

Hybrid mutual fund gains for NRIs are taxed based on the fund's equity allocation: equity-oriented or debt-oriented.

For Equity-Oriented Hybrid Funds (≥ 65% in Equity):

• Short-term capital gains: If you sell within 12 months, you will be liable to pay 20% tax.
• Long-term capital gains: If holding for more than 12 months, you will pay 12.5% tax on gains above Rs. 1.25 lakh per financial year.

For example, you invested Rs. 10 lakh in an aggressive hybrid fund, and you redeemed it for Rs. 13 lakh after 18 months (Rs. 3 lakh gain). The first Rs. 1.25 lakh gain will be exempt from taxation, and the remaining Rs. 1.75 lakh gain will be taxed at a rate of 12.5%. Overall, the amount would be Rs. 21,875 tax.

For Debt-Oriented Hybrid Funds (< 65% in equity):

All gains are subject to taxation as per your income tax slab rate, regardless of the holding period.

When redeemed, TDS is deducted at a rate of 30% for NRIs as per the Income Tax Act Section 195. Additionally, if your actual tax liability is lower, you are eligible to claim a refund when filing your ITR (Income Tax Returns).

How SIP Gains are Taxed for NRIs?

SIPs (Systematic Investment Plan) permit investors to invest a fixed amount regularly in mutual funds. For NRIs, SIP gains are taxed based on the type of mutual fund (equity or debt) and the holding period of each SIP installment. An investor can choose when to invest, like weekly, monthly, quarterly, biannually, or annually.

When you choose SIPs to invest in a mutual fund, you purchase a fixed number of units with each instalment. Additionally, for unit redemption, there is a first-in-first-out (FIFO) concept. The First in, First out method is the standard and legally required concept for calculating capital gains and associated tax obligations.

For example, if you invest in an equity fund via SIPs for one year and redeem the investment later after 13 months, then:

• Units purchased first (during the first few months) are held for the long term (over one year) and are liable for long-term capital gains tax (LTCG). No need to pay tax if the LTCG is under Rs. 1.25 lakh.
• Units purchased later (within the last 12 months) are considered as short-term capital gains (STCG) and are taxed at a rate of 15% (or 20% in some cases) with the applicable cess and surcharge.

What are the TDS Rules for NRIs on Mutual Fund Redemptions?

When redeeming mutual funds, NRIs are subject to TDS (Tax Deducted at Source) as per the specific TDS rate determined by the type of scheme (equity or non-equity) and the duration for which the funds were held. Here is how these are classified as either short-term or long-term gains:

• Short-Term Capital Gains: Profits earned from the sale of a mutual fund that had a holding period of one year or less.
• Long-Term Capital Gains: Profits earned from selling a mutual fund with a holding period of more than one year.

If the NRI falls under a lower tax slab, TDS is charged at the highest applicable rate. However, they can claim a refund when filing their returns.

What are the DTAA Benefits Offered to NRIs?

The issue of being taxed twice in India and your country of residency might stress you out. However, this is when the Double Taxation Avoidance Agreement (DTAA) helps. India has signed the DTAA agreement with over 90 countries.

DTAA is a treaty signed between two nations to prevent double taxation of the same income in two different nations for residents. Under the DTAA, gains received from investments made in India are taxed only in one nation, based on the terms of the agreement.

The main provision that permits this tax exemption is called the 'residual clause' in Article 13 of certain DTAAs. Under this clause, capital gains are subject to taxation only in the country of residence of the seller. It means you could potentially enjoy zero tax liability on mutual fund gains in India if you are a tax resident of a country like the Netherlands, Spain, Mauritius, Singapore, the UAE, or Portugal.

By submitting a Tax Residency Certificate (TRC), you can either:

• Qualify for a lower TDS rate in India as per the treaty.
• Claim credit for the tax paid in India against your tax liability in your residence country. 

What are the Repatriation Rules for Mutual Fund Gains?

NRIs who invest in Indian mutual funds have the option to repatriate their funds to their country of residence. However, repatriation is subject to compliance with the FEMA (Foreign Exchange Management Act) regulations and special guidelines issued by the RBI (Reserve Bank of India). Here are the repatriation limits based on the type of bank account used to invest:

• NRE Account Investments:Investments made through an NRE account are fully repatriable, including the principal amount and gains.
• NRO Account Investments: Repatriation from an NRO account is restricted to $1 million per financial year.
• Investment Made While Resident:If you purchased the mutual funds while you were a resident of India, your repatriation is also limited to $1 million every year.

Final Thoughts

An NRI Investing in mutual funds involves understanding specific tax rules and regulations. You can benefit from these investment opportunities effectively by using the right accounts and following the accurate process. It will help you diversify your portfolio, get access to India's high-growth potential economy, and have a regulated investment process.

Additionally, to improve your investment strategies and ensure compliance with Indian tax laws and international regulations, it's advisable to consult a tax expert. Talking about experts and Savetaxs tops the list. We have a team of experts who assist NRIs in managing their tax obligations and financial planning. They can ensure that you stay informed of your residency status and tax obligations associated with it. Contact us right away and avoid facing any penalties or legal repercussions due to non-compliance.