Capital Gains vs Interest Income - How NRI Investment Taxation Really Works

"I earned Rs 7 lakh from my FD and Rs 7 lakh from selling mutual funds. Why did I pay Rs 2.1 lakh tax on one and only Rs 70,000 on the other?"

This question landed in our Belong WhatsApp community from a Dubai-based NRI last month. And honestly, it captures the confusion that trips up even financially savvy NRIs.

After advising NRIs for over 12 years, I can tell you: the single biggest tax mistake isn't picking the wrong investment. It's not understanding how different income types are taxed. 

A 7% FD can leave you with less money than a 7% equity fund, simply because of how taxation works.

This guide breaks down the real difference between capital gains and interest income for NRIs. 

By the end, you'll know exactly which investments get taxed at what rate, how to claim refunds, and where to park your money for maximum tax efficiency.

What's the Real Difference Between These Two Income Types?

Before comparing tax rates, let's clarify what we're talking about.

Interest income is money you earn for lending your money to someone. 

When you put Rs 10 lakh in a fixed deposit, the bank pays you interest for using that money. You're guaranteed a return, regardless of market conditions.

Capital gains arise when you sell an asset for more than you paid. 

Buy mutual fund units at Rs 100, sell at Rs 150, and that Rs 50 profit is your capital gain. The gain only materializes when you sell.

This fundamental difference drives everything about how they're taxed.

👉 Tip: Interest income is taxed in the year it's earned (accrual basis). Capital gains are taxed only when you actually sell. This timing difference creates powerful tax planning opportunities.

How NRI Interest Income Gets Taxed

Your interest income taxation depends entirely on which account type you hold.

NRO Account Interest: The 30% Problem

Interest earned on NRO fixed deposits is fully taxable in India. Banks deduct TDS at 30% plus 4% cess (31.2% total) before crediting interest to your account (ClearTax).

Here's what that means practically:

Unlike resident Indians who enjoy a Rs 40,000 TDS threshold, NRIs have no such exemption. Every rupee of NRO interest attracts TDS from the first rupee earned (Tax2win).

NRE and FCNR: Tax-Free Interest

Interest on NRE fixed deposits and FCNR deposits is completely tax-free in India under Section 10(4)(ii) of the Income Tax Act.

No TDS deduction. No tax liability. Full interest credited to your account.

The catch? These accounts can only hold foreign-sourced income. Rental income from Indian property, dividends from Indian companies, or pension from an Indian employer cannot be deposited here.

👉 Tip: NRE and FCNR interest is tax-free in India but may be taxable in your country of residence. UAE NRIs benefit most since the UAE has no personal income tax.

GIFT City FD Interest: The Best of Both Worlds

GIFT City USD fixed deposits offer tax-free interest in India, similar to FCNR. But with key advantages:

For NRIs earning in dollars who want to avoid currency conversion, GIFT City FDs eliminate both rupee depreciation risk and Indian taxation.

Compare rates using our NRI FD comparison tool.

How NRI Capital Gains Get Taxed

Capital gains taxation is more nuanced. The tax rate depends on three factors:

1. Type of asset (equity, debt, property)
2. Holding period (short-term vs long-term)
3. Whether STT is applicable

Equity Mutual Funds and Stocks

For listed equity shares and equity-oriented mutual funds where Securities Transaction Tax (STT) is paid:

These rates were revised in Budget 2024. Earlier, STCG was 15% and LTCG was 10% (HDFC Life).

Critical point for NRIs: TDS is deducted at these same rates when you redeem. Unlike interest income where TDS often exceeds actual liability, equity fund TDS matches the final tax rate.

Debt Mutual Funds: The Changed Rules

Post-April 2023, debt fund taxation changed dramatically:

Debt funds purchased after April 2023 are treated like fixed deposits for tax purposes. Gains are added to your total income and taxed at slab rates (Bajaj Finserv).

For NRIs, this means TDS at 30% on all debt fund redemptions, regardless of holding period.

👉 Tip: If tax efficiency matters, consider equity-oriented hybrid funds with 65%+ equity allocation. They qualify for equity taxation rates (12.5-20%) rather than debt fund rates (up to 30%).

Property Capital Gains

Selling property in India triggers capital gains based on holding period:

The buyer must deduct TDS at 12.5% for LTCG or 30% for STCG on the entire sale amount, not just the gain (ClearTax).

A Real Property Sale Example

Vijay bought a flat in Mumbai for Rs 40 lakh in January 2020. He sells it in January 2025 for Rs 75 lakh.

Step 1: Determine holding period 5 years = Long-term capital asset

Step 2: Calculate LTCG (with indexation)

• Cost Inflation Index 2019-20: 289
• Cost Inflation Index 2024-25: 363
• Indexed cost: Rs 40 lakh × (363/289) = Rs 50.24 lakh
• LTCG: Rs 75 lakh - Rs 50.24 lakh = Rs 24.76 lakh
• Tax at 20%: Rs 4.95 lakh

Step 3: Calculate LTCG (without indexation)

• LTCG: Rs 75 lakh - Rs 40 lakh = Rs 35 lakh
• Tax at 12.5%: Rs 4.37 lakh

Vijay should choose the 12.5% option – saving Rs 58,000.

Step 4: TDS deduction by buyer The buyer deducts TDS at 12.5% on Rs 75 lakh = Rs 9.37 lakh.

But Vijay's actual liability is only Rs 4.37 lakh. He must file ITR to claim Rs 5 lakh refund.

👉 Tip: Property TDS for NRIs is calculated on sale consideration, not capital gains. Always file ITR to claim the substantial refund due.

Unlisted Shares and Startup Investments

NRIs investing in Indian startups through unlisted shares face different rules:

Budget 2024 reduced LTCG on unlisted shares from 20% to 12.5%, making startup investments more attractive for NRIs.

However, the main challenge isn't taxation – it's repatriation. Selling unlisted shares requires RBI approval for funds transfer abroad. The process is complex and typically requires a Chartered Accountant's certification.

The Real-World Tax Comparison

Let's compare what an NRI actually takes home from Rs 10 lakh invested in different instruments.

Scenario: Rs 10 Lakh Earning 7% Returns

The difference is stark. NRO FD interest faces 31.2% tax. The same Rs 70,000 from an equity fund held over 12 months faces only 12.5% tax and potentially zero tax if your total LTCG is under Rs 1.25 lakh.

👉 Tip: The Rs 1.25 lakh LTCG exemption is per financial year. By splitting redemptions across two financial years, you can effectively get Rs 2.5 lakh tax-free.

TDS Rates: The Complete NRI Reference

Here's a consolidated view of TDS rates for NRIs as of FY 2025-26 (Arthgyaan):

Important: TDS rates include 4% health and education cess. For income above Rs 50 lakh, surcharge also applies.

DTAA Benefits: Reducing Your Tax Burden

Double Taxation Avoidance Agreements can significantly reduce TDS on interest income. India has DTAAs with 90+ countries.

Country-Wise DTAA Rates on Interest Income

Source: HDFC Life

How to Claim DTAA Benefits

To get the reduced rate, submit these documents to your bank:

1. Tax Residency Certificate (TRC) from your country of residence
2. Form 10F generated online at incometax.gov.in
3. Self-declaration of no permanent establishment in India

These documents must be submitted annually, before interest payment dates.

👉 Tip: For UAE NRIs with significant NRO deposits, DTAA reduces TDS from 30% to 12.5%. On Rs 25 lakh NRO FD earning Rs 1.75 lakh interest, this saves Rs 30,625 annually. Learn more about claiming DTAA benefits.

The GIFT City Advantage

GIFT City investments offer a tax structure fundamentally different from mainland India:

Tax Comparison: GIFT City vs Mainland India

For NRIs in zero-tax jurisdictions like UAE, GIFT City effectively offers zero taxation on many investments since there's no tax in India and no tax in UAE.

Which GIFT City Investments Are Best?

Based on what we've seen work for our community members:

1. USD Fixed Deposits – Tax-free interest, no currency risk, 5% annual returns

2. GIFT City Mutual Funds – Tax-efficient equity exposure

• Tata India Dynamic Equity Fund – Rs 500 minimum
• DSP Global Equity Fund – Global diversification

1. Alternative Investment Funds – Category III AIFs invest in equity mutual funds with full capital gains exemption, minimum $75,000 (Belong Tax Guide)

Tax Exemptions NRIs Can Claim on Capital Gains

Unlike interest income where your only option is DTAA reduction, capital gains offer several exemption routes.

Section 54: Reinvest in Residential Property

If you sell property after 24 months and invest the capital gains in another residential property within:

• 2 years (purchase) or
• 3 years (construction)

You can claim full exemption on the LTCG amount invested (ClearTax).

Section 54EC: Invest in Capital Gain Bonds

Invest up to Rs 50 lakh of LTCG in NHAI or REC bonds within 6 months of property sale. The bonds have a 5-year lock-in but offer complete exemption on the invested amount.

The bonds pay around 5-5.5% interest annually, which is taxable at slab rates. But the capital gains exemption more than compensates (Fincart).

Section 54F: Reinvest Non-Property LTCG

If you have LTCG from selling shares, mutual funds, or other capital assets (not property), you can claim exemption by investing the entire sale proceeds (not just gains) in a residential property.

👉 Tip: Section 54F requires investing the full sale proceeds, not just the gain. If you sell shares worth Rs 50 lakh (Rs 30 lakh gain), you must invest Rs 50 lakh in property to get full exemption.

Rs 1.25 Lakh LTCG Exemption

For listed equity and equity mutual funds, LTCG up to Rs 1.25 lakh per financial year is completely exempt. This exemption is automatic – no investment or filing required.

Understanding TDS vs Final Tax Liability

This distinction confuses many NRIs. Let me clarify.

TDS (Tax Deducted at Source) is an advance tax payment. The bank or fund house deducts it before paying you. It's not necessarily your final tax.

Final tax liability is what you actually owe based on your total income and applicable rates.

These two are often different.

When TDS Exceeds Final Liability

Consider this scenario:

Rakesh, a Dubai NRI, has Rs 10 lakh in an NRO FD earning Rs 70,000 interest. His bank deducts Rs 21,840 (31.2%) as TDS.

But Rakesh has no other Indian income. His total taxable income is Rs 70,000, which falls below the Rs 2.5 lakh basic exemption limit.

His actual tax liability? Zero.

By filing an ITR, Rakesh can claim a full refund of Rs 21,840.

This happens more often than you'd expect. Many NRIs leave thousands of rupees on the table simply by not filing returns.

When Final Liability Exceeds TDS

The reverse also occurs, particularly with capital gains.

Say Meera sells mutual funds with Rs 8 lakh LTCG. TDS is deducted at 12.5% (Rs 1 lakh). But Meera also has Rs 5 lakh rental income taxed at 30%.

Her combined tax liability exceeds TDS deducted. She must pay the shortfall as self-assessment tax before filing ITR.

👉 Tip: If your estimated annual tax exceeds Rs 10,000 beyond TDS, you must pay advance tax in quarterly instalments. Missing this attracts interest under Sections 234B and 234C.

Interest Income vs Capital Gains: Key Structural Differences

Beyond tax rates, these income types differ in ways that affect your investment strategy.

Timing of Taxation

Interest income: Taxed annually on accrual basis. Even if you don't withdraw interest, tax is due for the year it's credited.

Capital gains: Taxed only on realization. You control when to trigger the tax event by choosing when to sell.

This timing difference is powerful. With capital gains, you can:

• Defer taxes indefinitely by not selling
• Choose which financial year to book gains
• Time sales for maximum tax efficiency

Loss Offset Rules

Interest income: Cannot be offset against any losses. If you earn Rs 70,000 interest and have Rs 1 lakh business loss, you still pay tax on the full Rs 70,000.

Capital gains: Can be offset against capital losses.

• Short-term loss offsets both STCG and LTCG
• Long-term loss offsets only LTCG
• Excess losses carry forward for 8 years

This creates tax planning opportunities unavailable with interest income.

Example: Tax-Loss Harvesting

Ajay has Rs 3 lakh LTCG from selling Fund A. He also holds Fund B which is down Rs 2 lakh.

By selling Fund B (booking the loss) and immediately repurchasing, he offsets Rs 2 lakh against his gains. Taxable LTCG reduces to Rs 1 lakh.

With the Rs 1.25 lakh exemption, Ajay pays zero tax on what would have been Rs 37,500 liability.

You cannot do this with interest income.

👉 Tip: Review your portfolio every March. Identify unrealized losses that can offset gains before the financial year ends.

Dividend Income: A Third Category

While we're focusing on interest and capital gains, dividend income deserves mention as it confuses many NRIs.

Since April 2020, dividends are taxable in the hands of investors (not the company). For NRIs:

TDS of 20% is deducted on all dividends paid to NRIs (Tata AIA).

Growth vs Dividend Plans

For NRIs, growth plans are almost always more tax-efficient than dividend plans:

The math is clear. A Rs 10 lakh investment growing at 12% for 10 years:

Growth plan: Final value Rs 31 lakh. Tax on Rs 21 lakh gain at 12.5% = Rs 2.48 lakh (after Rs 1.25 lakh exemption).

Dividend plan (assuming 10% annual dividend): Each Rs 1 lakh dividend taxed at 20% = Rs 20,000 annual tax. Total tax over 10 years = Rs 2 lakh. Plus, reduced compounding means lower final corpus.

Growth plans win on both tax efficiency and compounding.

Rental Income: Neither Interest Nor Capital Gains

Rental income from Indian property is taxed as "Income from House Property" – a separate head altogether.

How Rental Income is Taxed

TDS at 30% is deducted by the tenant (if monthly rent exceeds Rs 50,000) on the gross rent, not the taxable amount.

For NRIs, this often means TDS far exceeds actual liability. Filing ITR is essential to claim refunds.

👉 Tip: If you're an NRI landlord receiving rent, ensure your tenant deducts TDS correctly. Many tenants mistakenly deduct at 1% (resident rate) instead of 30% (NRI rate), creating complications for both parties.

Common Tax Mistakes NRIs Make

After reviewing thousands of NRI portfolios, here are the mistakes I see repeatedly:

Mistake 1: Not Claiming DTAA Benefits

Most NRIs pay 30% TDS on NRO interest when they could pay 12.5-15% through DTAA. The paperwork takes 30 minutes, but saves thousands of rupees.

Mistake 2: Selling Equity Funds Before 12 Months

STCG at 20% vs LTCG at 12.5%. On Rs 5 lakh gain, that's Rs 37,500 extra tax for being a few days impatient.

Mistake 3: Ignoring the Rs 1.25 Lakh Exemption

Many NRIs redeem everything in one go. By splitting across financial years, the same Rs 2.5 lakh gain can be completely tax-free.

Mistake 4: Using NRO for Foreign Income

Foreign earnings should go to NRE accounts (tax-free interest) not NRO (30% TDS). This single routing decision can save lakhs over time.

Mistake 5: Not Filing ITR to Claim Refunds

TDS is often higher than actual liability. Without filing an ITR, you forfeit refunds that could be substantial.

👉 Tip: Use our Compliance Compass to check if you're meeting all tax obligations.

Tax-Efficient Investment Strategies

Based on everything we've covered, here's how to structure investments for optimal tax efficiency:

Strategy 1: Segregate by Account Type

Strategy 2: Use the Holding Period to Your Advantage

• Equity funds: Always hold beyond 12 months unless market conditions demand otherwise
• Property: Plan sales after 24-month holding for LTCG rates
• Debt funds (pre-April 2023): Hold beyond 36 months for lower rates

Strategy 3: Annual Tax Harvesting

Every March, consider redeeming equity funds up to Rs 1.25 lakh LTCG. Reinvest immediately. You've "crystallized" gains tax-free and reset your cost basis.

Strategy 4: Consider GIFT City for New Investments

For fresh investments, evaluate GIFT City options seriously. The tax advantages compound significantly over time.

Strategy 5: Maximize Exemptions Through Planning

Capital gains exemptions require planning, not last-minute decisions:

For property sales (Section 54):

• Identify target properties before selling
• Keep purchase funds ready to deploy within timeline
• Open Capital Gains Account Scheme (CGAS) if you need more time

For the Rs 1.25 lakh LTCG exemption:

• Track your cumulative LTCG throughout the year
• Redeem strategically to stay within the limit
• Spread large redemptions across multiple financial years

For Section 54EC bonds:

• NHAI and REC bonds have limited availability
• Mark your calendar for the 6-month deadline
• Don't wait until the last week

Strategy 6: Structure Your Portfolio by Tax Efficiency

Here's how I suggest NRIs organize their investments:

Tax-Free Zone (Safety): 20-30% of portfolio

• NRE Fixed Deposits
• GIFT City USD Fixed Deposits
• FCNR Deposits

Tax-Efficient Zone (Growth): 50-60% of portfolio

• Equity mutual funds (hold over 12 months)
• Direct equity (long-term)
• GIFT City mutual funds

Tax-Heavy Zone (Minimize): 10-20% or as needed

• NRO Fixed Deposits
• Debt funds (post-2023)
• Short-term trading

The goal is to maximize holdings in the first two zones while minimizing the third.

Country-Specific Tax Considerations

Your country of residence dramatically affects your overall tax picture. Let me break this down for the most common NRI destinations.

UAE NRIs: The Most Tax-Efficient Position

UAE has no personal income tax. This creates an ideal situation:

The key is claiming India-UAE DTAA benefits to reduce NRO TDS from 30% to 12.5%.

For UAE NRIs, GIFT City investments are particularly attractive. Zero Indian tax plus zero UAE tax equals completely tax-free returns.

👉 Tip: UAE NRIs must obtain a Tax Residency Certificate from the Ministry of Finance to claim DTAA benefits. Cost is around AED 500, valid for one year.

US NRIs: The PFIC Complication

US residents face unique challenges due to Passive Foreign Investment Company (PFIC) rules.

Indian mutual funds qualify as PFICs. This triggers:

• Annual Form 8621 filing for each fund
• Punitive "excess distribution" taxation
• Tax on unrealized gains in some cases
• Effective rates exceeding 50% in worst cases

What's NOT a PFIC:

• Direct Indian stocks
• NRE/NRO fixed deposits
• Indian real estate
• PPF (existing accounts)
• GIFT City structures (potentially cleaner)

For US NRIs, the math often favors direct stocks and FDs over mutual funds, despite the diversification benefits of funds.

Learn more about US NRI tax complications.

UK NRIs: Self-Assessment Requirements

UK tax residents must report worldwide income on their Self Assessment return.

Key points:

• Indian capital gains are taxable in UK at 10% (basic rate) or 20% (higher rate)
• NRE interest is tax-free in India but taxable in UK
• DTAA allows credit for Indian taxes paid
• Non-domiciled status offers some protection

The India-UK DTAA ensures you don't pay tax twice, but you do pay the higher of the two countries' rates.

Canada NRIs: T1135 Reporting

Canadian residents don't face PFIC issues but have foreign asset reporting:

Indian mutual funds are not subject to the harsh treatment US NRIs face. However, all gains must be reported on Canadian returns.

Comparing Returns After Tax: The Real Picture

Raw returns mean nothing without understanding what you keep after tax. Let me show you what Rs 10 lakh actually yields across different investments.

10-Year Projection: Rs 10 Lakh Investment

*Plus currency appreciation if rupee depreciates

The NRE FD nets Rs 6.61 lakh more than NRO FD over 10 years – purely from tax savings.

The equity fund, despite higher volatility, delivers Rs 8.91 lakh more than NRE FD after tax – thanks to both better returns and favorable capital gains treatment.

👉 Tip: Don't compare pre-tax returns. Always calculate post-tax returns for your specific situation. Use our tools at Belong to model different scenarios.

Form 15CA and 15CB: Repatriation Documentation

When you transfer money out of India (from NRO or after selling property), you may need to furnish Form 15CA and 15CB.

When is Form 15CA/15CB Required?

Form 15CB is a certificate from a Chartered Accountant confirming that appropriate taxes have been paid. Without this, banks will not process the remittance.

Learn more about repatriating funds from India.

What Happens When You Return to India?

Tax treatment changes significantly when you become a resident Indian. Understanding this helps you plan ahead.

RNOR Status: The 2-3 Year Buffer

When you return, you likely qualify as Resident but Not Ordinarily Resident (RNOR) for 2-3 years. During RNOR:

• Foreign income remains non-taxable in India
• Indian income is taxable as normal
• NRE accounts must be converted to resident accounts
• FCNR can continue until maturity

Use our Residential Status Calculator to determine your exact status.

Converting NRI Accounts

Learn more about converting NRI accounts to resident accounts.

Tax Planning Before Return

If you're planning to return in the next 1-2 years:

1. Redeem investments with large gains before returning – NRI capital gains rates may be more favorable than resident rates for certain investments

2. Mature FDs before return – NRE interest remains tax-free until conversion

3. Don't open new NRE FDs close to return – They'll convert to taxable resident FDs mid-tenure

4. Consider GIFT City investments – Some can continue even after becoming resident

Record-Keeping Requirements

Good documentation prevents tax disputes later. Here's what to maintain:

For Interest Income

• Bank statements showing interest credited
• TDS certificates (Form 16A from banks)
• TRC and Form 10F copies (for DTAA claims)
• Form 26AS showing TDS credits

For Capital Gains

• Purchase receipts/contract notes
• Sale receipts/contract notes
• Cost of improvement documentation
• Holding period proof
• Reinvestment documentation (for exemptions)
• Demat statements

How Long to Keep Records?

Indian tax authorities can reassess returns up to 6 years back (10 years for undisclosed foreign assets). Keep all investment records for at least 7 years from the date of selling the asset.

👉 Tip: Digitize everything. Scan all physical documents and store in cloud. Physical papers deteriorate; digital copies don't.

Special Situations and Edge Cases

Inherited Property

If you inherit property in India:

• There's no tax on inheritance itself
• Capital gains tax applies when you sell
• Your holding period includes the previous owner's period
• Cost basis is the previous owner's purchase cost (not market value at inheritance)

This means if your father bought a flat in 1990 for Rs 5 lakh and you inherit and sell it today for Rs 1 crore, your LTCG is calculated from the Rs 5 lakh base (indexed to today's CII).

Learn more about Section 54 exemptions.

Gifted Investments

Similar rules apply to gifts:

• No tax on receiving the gift (up to Rs 50,000 from non-relatives)
• Capital gains calculated from donor's cost
• Holding period includes donor's holding period

Learn about gift tax rules for NRIs.

Joint Holdings with Resident Indian

Interest on joint NRE accounts where one holder is resident:

• Account must be converted to NRO
• Interest becomes taxable
• TDS deducted at 30%

This is a common issue when NRIs add parents as joint holders for convenience.

Comparing Returns After Tax: The Real Picture

Raw returns mean nothing without understanding what you keep after tax. Let me show you what Rs 10 lakh actually yields across different investments.

10-Year Projection: Rs 10 Lakh Investment

*Plus currency appreciation if rupee depreciates

The NRE FD nets Rs 6.61 lakh more than NRO FD over 10 years – purely from tax savings.

The equity fund, despite higher volatility, delivers Rs 8.91 lakh more than NRE FD after tax – thanks to both better returns and favorable capital gains treatment.

👉 Tip: Don't compare pre-tax returns. Always calculate post-tax returns for your specific situation. Use our tools at Belong to model different scenarios.

Filing Requirements: When Must You File?

Even if TDS covers your full liability, filing ITR makes sense when:

• You want to claim refunds (TDS exceeded actual tax)
• You have capital losses to carry forward
• Your total income exceeds Rs 2.5 lakh
• You want to claim DTAA benefits formally
• You have assets exceeding Rs 1 crore in India

NRIs typically file ITR-2 for salary, rental, and capital gains income. Those with business income use ITR-3 (Tax2win).

Belong's tax filing service handles NRI returns with clear pricing starting Rs 2,000.

The Bottom Line

Capital gains and interest income are taxed fundamentally differently:

For most NRIs:

• NRE and GIFT City FDs for safety and tax-free returns
• Equity funds for growth with favorable capital gains rates
• Avoid debt funds unless through NRE (not tax-efficient post-2023)
• Use DTAA to reduce NRO interest taxation
• File ITR to claim rightful refunds

Tax efficiency isn't about avoiding compliance. It's about understanding rules and structuring investments to legally minimize what you owe.

Ready to optimize your tax structure? Join our WhatsApp community where NRIs discuss real tax scenarios daily. Or download the Belong app to explore tax-efficient investment options.

Sources:

• Income Tax Department of India
• ClearTax NRI Taxation Guide
• HDFC Life NRI Tax Guide
• Bajaj Finserv Mutual Fund Taxation
• Arthgyaan TDS Rates for NRIs
• Tax2win NRI Capital Gains