Introduction

For NRIs, investing in Indian mutual funds can be a smart financial move. However, understanding how capital gains tax applies to these investments is crucial. Whether you’re an NRI in the UAE, the US, or elsewhere, being aware of tax implications helps you make more informed decisions and avoid unpleasant surprises. Let’s dive into the key aspects of capital gains tax on Indian mutual funds and how they impact NRIs like you.

STCG vs LTCG: The Basics

In India, your mutual fund profits are categorized into two types—short-term capital gains (STCG) and long-term capital gains (LTCG). The difference depends on how long you’ve held onto your mutual fund units.

Equity-Oriented Funds

If your mutual fund invests primarily in stocks, here’s what you need to know:

• STCG: Sold within 12 months? The gains are taxed at 15%.

• LTCG: Sold after 12 months? Gains above ₹1 lakh in a financial year are taxed at 12.5%.

Debt-Oriented Funds

These are funds that invest in bonds and other fixed-income securities.

• STCG: If you sell within 36 months, the gains are added to your income and taxed according to your tax slab.

• LTCG: If you hold for more than 36 months, your gains are taxed at 20%, but you get the benefit of indexation (this adjusts the purchase price for inflation, reducing your taxable gain).

Sounds straightforward so far, right? But what if you’re living outside India? That’s where it gets a little more interesting.

How DTAA Can Help

If you’re an NRI, the Double Taxation Avoidance Agreement (DTAA) between India and your country of residence plays a significant role in your tax planning. DTAAs are agreements between two countries to ensure you don’t pay tax on the same income twice.

For example, under most DTAAs:

• You can claim a tax credit in your country of residence for taxes paid in India.

• In some cases, DTAAs set a maximum tax rate on your income, such as capital gains, in India, ensuring you don’t face higher tax rates.

It’s essential to provide documentation to the bank, such as a Tax Residency Certificate (TRC) from your country of residence, to benefit from DTAA provisions.

Did You Know?

A Tax Residency Certificate (TRC) is required to claim tax relief under DTAA and avoid double taxation. US investors need to provide a tax return and residency proof, UK investors need a letter from HMRC, and UAE investors must submit a residency visa and income proof. 

Impact for UAE-Based NRIs

If you’re based in the UAE, you’re in a favorable position when it comes to investing in mutual funds. Here’s why:

1. No Capital Gains Tax in the UAE: The UAE doesn’t tax personal income, including capital gains, so you’re only subject to Indian taxes.

2. Mutual Funds vs. Stocks: Under the India-UAE DTAA, while capital gains on stocks are taxable in India, capital gains from mutual funds are not taxable in India. Even if TDS (Tax Deducted at Source) is applied to your mutual fund gains, you can claim a refund by filing your returns in India.

3. How to Claim a Refund:

   1. Obtain a Tax Residency Certificate (TRC) from the UAE.

   2. Fill out Form 10F and submit it along with your Indian income tax return.

This tax advantage makes mutual funds a better investment choice than stocks for UAE-based NRIs.

Impact for US-Based NRIs

For US-based NRIs, understanding tax rules for investments is important, especially when it comes to PFICs and stocks. Here are the key points:

• PFIC and Capital Gains:

  • PFIC gains are taxed every year, even if the investment is not sold.

  • These gains are taxed as ordinary income, which can be as high as 37%.

  • NRIs need to file IRS Form 8621 for each PFIC investment every year.

  • As per DTAA, if NRI has paid capital gains on mutual fund profits in India, they are eligible to get a full tax-refund if they pay PFIC tax in the US.

• Stock Investments:

  • Direct investments in foreign stocks, like shares of Indian companies, are not considered PFICs.

  • These stocks follow regular capital gains tax rules, without the need for complex reporting.

Impact for NRIs from Other Countries

If you’re an NRI from a country other than the UAE or the US, the impact of capital gains tax depends on whether your country has a DTAA with India:

• Countries with DTAA: NRIs can reduce tax liabilities or claim tax credits for taxes paid in India through DTAA. For instance, NRIs in the UK, US, Canada, Australia, Singapore, UAE, Saudi Arabia, France, and Germany can benefit from these agreements to avoid double taxation.

• Countries without DTAA: If no agreement exists, you may end up paying taxes in both India and your country of residence, increasing your overall tax liability.

It’s essential to check the specific terms of the DTAA between India and your country to determine how your mutual fund gains will be taxed.

Conclusion

Capital gains tax on Indian mutual funds can seem tricky, but understanding it helps you make smarter investment decisions. As an NRI, knowing the rules for STCG and LTCG, leveraging DTAA benefits, and staying compliant with tax laws in both India and your country of residence can save you money and maximize your returns.