How Mutual Fund Profits Are Taxed When You Withdraw

Last month, a member from our WhatsApp community in Dubai panicked after redeeming ₹20 lakh from an equity fund.

The AMC deposited only ₹18.75 lakh into his NRE account. "Where did ₹1.25 lakh go?" he asked.

The answer was TDS. Tax Deducted at Source. The fund house cut it before he even saw the money.

This is the part about mutual fund investing that catches most NRIs off guard. You research funds, start a SIP, watch your portfolio grow for years. Then when you finally withdraw, a chunk disappears before it reaches your bank account.

At Belong, we hear this question every week. How much tax will I actually pay? Does it depend on the fund type? Can I get the TDS back? Is there a way to pay less - or nothing at all?

This guide answers all of it. We'll walk through exactly how each fund type is taxed, what TDS rates apply to NRIs, how to claim refunds, and one route where capital gains tax drops to zero.

Your Original Investment Isn't Taxed. Only the Profit Is.

Before anything else, this needs to be clear. When you redeem mutual fund units, the tax applies only on your profit - not on the full amount you receive.

Your profit is the difference between what you sold the units for (redemption value) and what you originally paid (purchase cost). This profit is called capital gains.

Say you invested ₹10 lakh and it grew to ₹14 lakh. Your capital gain is ₹4 lakh. Tax applies only on this ₹4 lakh. The original ₹10 lakh comes back to you untouched.

For SIP investments, this calculation happens unit by unit. Each SIP installment was purchased at a different NAV on a different date. When you redeem, the system uses First In, First Out (FIFO) - meaning the oldest units are sold first.

👉 Tip: FIFO matters for tax planning. If your earliest SIP installments are older than 12 months, those units qualify for long-term capital gains treatment even if recent installments don't.

What Decides Your Tax Rate: Fund Type + Holding Period

Two factors determine how your mutual fund profit is taxed:

Factor 1: What kind of fund is it?

The Income Tax Act classifies mutual funds into three tax buckets based on where the fund invests its money (Source: AMFI Tax Regime):

Equity-oriented funds invest at least 65% in listed Indian equities. This includes large-cap, mid-cap, small-cap, flexi-cap, ELSS, and most index funds.

Debt-oriented funds (called "specified mutual funds" from FY 2025-26) invest more than 65% in debt and money market instruments. This includes liquid funds, corporate bond funds, gilt funds, and money market funds (Source: Finance Act 2024, Section 50AA).

Other funds include hybrid funds (35-65% equity), gold funds, international funds, and fund-of-funds. These have their own holding periods and rates.

Factor 2: How long did you hold it?

The holding period determines whether your gain is short-term or long-term. Longer holding periods attract lower tax rates.

Source: Finance (No. 2) Act 2024, applicable from FY 2025-26 (Source: HSBC Tax Reckoner FY 2025-26)

Equity Fund Taxation: The Most Common Scenario

Most NRI investors hold equity mutual funds. Here's what happens when you withdraw.

Short-Term Capital Gains (held 12 months or less)

Tax rate: 20% flat (plus 4% cess)

This rate applies regardless of your income slab. It doesn't matter if your total income is ₹3 lakh or ₹30 lakh. Equity STCG is always 20%.

Before July 2024, this rate was 15%. The Union Budget 2024 raised it (Source: Finnovate Tax Guide).

Long-Term Capital Gains (held over 12 months)

Tax rate: 12.5% flat (plus 4% cess)

But there's an important exemption. The first ₹1.25 lakh of LTCG across all equity investments in a financial year is tax-free.

This exemption was raised from ₹1 lakh in Budget 2024 (Source: Finance (No. 2) Act 2024, Section 112A).

Example: Ravi in Abu Dhabi

Ravi invested ₹15 lakh in a flexi-cap fund in March 2024. He redeems in June 2025 (15 months later) at ₹19 lakh.

Capital gain: ₹4 lakh

Exemption: ₹1.25 lakh

Taxable gain: ₹2.75 lakh

Tax at 12.5%: ₹34,375

Plus 4% cess: ₹1,375

Total tax: ₹35,750

Out of ₹4 lakh profit, Ravi keeps ₹3,64,250. The effective tax rate on his total profit is about 8.9%.

👉 Tip: The ₹1.25 lakh exemption is per financial year, not per fund or per transaction. If you redeem from three different equity funds, the combined LTCG from all three shares this single ₹1.25 lakh limit.

Debt Fund Taxation: The Rule That Changed Everything

If you hold debt mutual funds purchased after April 1, 2023, the tax treatment is harsh.

All gains whether you held the fund for 6 months or 6 years are taxed at your income tax slab rate. There is no long-term benefit. No reduced rate. No indexation (Source: Section 50AA, Income Tax Act).

This was introduced in the Finance Act 2023 and applies to all "specified mutual funds" where more than 65% of assets are in debt and money market instruments.

For NRIs, the slab rates (old regime, FY 2025-26) are:

Source: ClearTax NRI Tax Guide

Example: Meera in Dubai

Meera invested ₹20 lakh in a corporate bond fund in January 2024. She redeems in July 2026 (30 months later) at ₹24 lakh.

Capital gain: ₹4 lakh

Even though she held for over 24 months, the gain is taxed at slab rate - not 12.5%.

If this ₹4 lakh is her only Indian income, most of it falls within the ₹2.5 lakh exemption slab. She pays effectively very little.

But if she also has ₹6 lakh rental income, her total income is ₹10 lakh. The ₹4 lakh debt fund gain gets taxed at 20-30% depending on the slab.

👉 Tip: Debt fund taxation makes them less attractive for NRIs with other Indian income. If you have rental income or NRO interest, adding debt fund gains on top pushes you into higher slabs. Consider GIFT City alternatives where gains are tax-exempt for NRIs.

Hybrid, Gold, and International Fund Taxation

These funds fall between equity and debt both in risk profile and tax treatment.

Hybrid funds with 35-65% equity (balanced hybrid, multi-asset, aggressive hybrid below 65%)

Holding period for LTCG: More than 24 months

STCG: Taxed at slab rate

LTCG: 12.5% without indexation

Gold funds, gold ETFs, international equity funds, fund-of-funds

Same as hybrid: 24-month threshold for long-term treatment.

STCG at slab rate. LTCG at 12.5%.

Before July 2024, gold and international funds needed 36 months for LTCG treatment and got 20% with indexation. That benefit is now gone (Source: Finnovate Tax Guide).

Hybrid funds with 65%+ equity (equity-oriented)

These are taxed exactly like equity funds 12-month threshold, 20% STCG, 12.5% LTCG with ₹1.25 lakh exemption.

Check your fund's scheme information document (SID) to confirm its equity allocation. The fund category name can be misleading.

The TDS Problem: Why NRIs Get Less Money Than Expected

This is the biggest difference between how residents and NRIs experience mutual fund withdrawals.

When a resident Indian redeems mutual funds, no TDS is deducted. They pay tax later when filing their ITR.

When an NRI redeems, the fund house deducts TDS immediately before crediting the money (Source: AMFI Tax Regime).

Current TDS rates for NRIs on mutual fund redemption (FY 2025-26):

Source: Equitymaster NRI MF Taxation, HSBC Tax Reckoner 2025-26

Plus 4% health and education cess on all rates. Plus applicable surcharge if your Indian income exceeds ₹50 lakh.

Critical detail for NRIs without PAN: If you haven't provided your PAN to the fund house, TDS jumps to 20% regardless of the applicable rate (Source: Section 206AA, Income Tax Act).

👉 Tip: TDS is not your final tax. It's an advance payment. If the TDS deducted exceeds your actual tax liability, you can claim a refund by filing your ITR. Many NRIs with low Indian income leave money on the table by not filing.

Can You Get TDS Back? Yes, Here's How

Many NRIs overpay tax through TDS. The fund house deducts at the maximum applicable rate without considering your exemptions, deductions, or lower slab eligibility.

You claim the excess back by filing an Income Tax Return.

When you'll likely get a refund:

Your total Indian income (including capital gains) falls below ₹2.5 lakh. The TDS gets fully refunded.

Your equity LTCG is below ₹1.25 lakh. The TDS on that amount is refundable since the gain was within the exemption limit.

You have losses from other funds that offset the gains. The net taxable gain reduces, making part of TDS refundable.

How to claim:

File ITR-2 (the form NRIs with capital gains must use) by July 31 of the assessment year (Source: Income Tax Department).

Check your Form 26AS or Annual Information Statement (AIS) to verify TDS amounts match what the fund house deducted.

Pre-validate your Indian bank account on the e-filing portal to avoid refund delays.

Refunds typically take 3-6 months after processing.

👉 Tip: You must file your ITR before the due date (July 31) if you want to carry forward capital losses. Miss the deadline, and you lose the right to carry losses forward even if you file a belated return later.

Dividend Income: Taxed Differently From Capital Gains

When your mutual fund declares a dividend (now called IDCW - Income Distribution cum Capital Withdrawal), that money is taxed separately from capital gains.

Dividends are added to your total income and taxed at your slab rate. They're not treated as capital gains (Source: Tata Mutual Fund Tax Reckoner).

TDS on dividends for NRIs: 20% (or the DTAA rate, whichever is lower).

If total dividends from a single AMC are below ₹5,000 in a financial year, no TDS applies (Source: AMFI).

This is one reason growth plans are more tax-efficient than IDCW plans for most NRIs. With growth plans, your money compounds untaxed until you decide to redeem. With IDCW, every payout triggers immediate tax at slab rates.

Also Read: Growth Option vs IDCW Option in Mutual Funds

Switching Between Funds Is a Taxable Event

Here's a trap many NRIs walk into. You switch from Fund A to Fund B within the same AMC. You think it's just a portfolio rebalance. No money left your account.

But the tax department treats it as a redemption from Fund A (triggering capital gains) followed by a fresh purchase in Fund B (Source: Belong Tax Guide).

If Fund A had unrealized gains, those gains are now realized. TDS will be deducted on the gains at the time of the switch.

Example:

You have ₹10 lakh in a large-cap fund (original cost: ₹7 lakh). You switch to a mid-cap fund.

Capital gain realized: ₹3 lakh

If held over 12 months: LTCG at 12.5% after ₹1.25 lakh exemption

TDS deducted immediately on the gain

👉 Tip: If you're sitting on large unrealized gains, switch in tranches across financial years. This lets you use the ₹1.25 lakh LTCG exemption each year instead of exhausting it in one shot.

The DTAA Safety Net: Avoiding Double Taxation

As an NRI, you might worry about paying tax twice once in India and again in your country of residence.

The India-UAE DTAA protects against this. So do India's treaties with the US, UK, Canada, and over 90 other countries.

How it works for mutual fund gains:

Capital gains from Indian mutual funds are taxed in India (since the asset is in India).

When you file taxes in your resident country, you claim a Foreign Tax Credit (FTC) for the tax already paid in India.

Your resident country reduces your tax liability by the Indian tax already paid.

For UAE-based NRIs: Since the UAE has no personal income tax, you pay tax only in India. There's no double taxation to worry about. The India-UAE DTAA primarily helps in getting lower TDS on dividends (12.5% under treaty vs 20% standard rate).

For US-based NRIs: You report Indian mutual fund gains on your US tax return. India taxes them first. You claim FTC in the US. However, US NRIs also face PFIC (Passive Foreign Investment Company) rules, which can make Indian mutual funds very tax-inefficient.

To claim DTAA benefits, you need:

A Tax Residency Certificate (TRC) from your country of residence

Form 10F filed with Indian tax authorities

Proof that you're the beneficial owner of the income

Source: Rupeeflo TDS Rules

Also Read: DTAA Benefits on Capital Gains for NRIs

Offsetting Losses Against Gains: A Tax-Saving Tool

Not every mutual fund redemption results in profit. Sometimes you sell at a loss. Those losses can reduce your tax bill.

Set-off rules (same financial year):

Short-term capital loss (STCL) can be set off against both STCG and LTCG from any asset.

Long-term capital loss (LTCL) can be set off only against LTCG not against STCG.

Carry forward rules:

If losses exceed gains in a year, carry them forward for up to 8 assessment years.

You must file your ITR by the July 31 due date to carry forward losses. Belated returns don't qualify (Source: Income Tax Act, Section 80).

Example:

You redeem Fund A: LTCG of ₹3 lakh

You redeem Fund B: LTCL of ₹2 lakh

Net taxable LTCG: ₹1 lakh (below the ₹1.25 lakh exemption)

Tax payable: Zero

Without setting off the loss, you'd owe tax on ₹1.75 lakh (₹3 lakh minus ₹1.25 lakh exemption). The loss saves you ₹21,875 in tax.

Also Read: Tax-Loss Harvesting in Mutual Funds

Repatriation After Withdrawal: Is There More Tax?

Good news. There's no additional tax when you send mutual fund proceeds abroad.

If you invested through an NRE account, the redemption proceeds (principal + gains) are fully repatriable. The gains are taxed at source (TDS), and no further tax applies on the transfer.

If you invested through an NRO account, the proceeds are repatriable up to USD 1 million per financial year (under the FEMA guidelines). You'll need Form 15CA and 15CB - a CA-certified declaration that appropriate taxes have been paid.

Documents needed for repatriation:

Form 15CA (online declaration by the NRI)

Form 15CB (CA certificate confirming tax compliance) - required for remittances above ₹5 lakh

Fund house statements showing TDS deducted

PAN card details

Source: Income Tax Portal

Also Read: Repatriation Rules for NRIs After Selling Investments

👉 Tip: If you plan to repatriate funds from NRO account redemptions, keep your tax filings current. Banks often ask for ITR receipts and Form 15CB before processing the transfer.

The GIFT City Route: Zero Capital Gains Tax

Everything above applies to regular Indian mutual funds regulated by SEBI.

There's another category: GIFT City mutual funds - regulated by IFSCA (International Financial Services Centres Authority).

For NRIs, capital gains on these funds are exempt from Indian tax under Section 10(4D) of the Income Tax Act (Source: Income Tax Act, Section 10(4D)).

What this means practically:

No capital gains tax in India regardless of holding period

No TDS deducted on redemption

No Indian ITR filing required (if this is your only Indian income)

Investments and returns are in USD no currency conversion risk

Full repatriation without Form 15CA/15CB

For UAE-based NRIs: India exempts the gains. UAE has no capital gains tax. Combined tax rate: 0%.

Minimum investments are now accessible:

Retail mutual funds: Starting from $500 (following Tata's September 2025 GIFT City launch)

AIFs (Alternative Investment Funds): From $75,000 (reduced from $150,000 in February 2025)

The tax holiday for GIFT City has been extended to March 2030 through Union Budget 2025.

Compare this to the regular route where you pay 12.5% LTCG (equity) or up to 30% (debt). For large portfolios, the tax savings are significant.

Also Read: GIFT City Mutual Funds vs Regular Bank FDs

👉 Tip: GIFT City tax-free status applies in India. Your home country may still tax these gains. UK NRIs face CGT. US NRIs face PFIC rules. UAE NRIs pay nothing because the UAE has no capital gains tax. Always check both sides.

Complete Tax Rate Comparison Table

Here's everything in one place for FY 2025-26:

Sources: HSBC Tax Reckoner 2025-26, AMFI, Income Tax Act Section 10(4D)

What Changes If You Return to India?

Your tax status changes. And with it, your mutual fund taxation.

Once you become a Resident Indian (or RNOR — Resident but Not Ordinarily Resident), your worldwide income becomes taxable in India. But specifically for mutual fund gains:

TDS no longer applies on equity fund redemptions (residents are exempt from TDS on mutual fund capital gains).

You still pay capital gains tax through self-assessment when filing ITR.

The tax rates remain the same - 20% STCG, 12.5% LTCG for equity funds.

For debt funds, you continue paying at slab rate.

The key action: Inform your AMC when your residential status changes. Update your KYC from NRI to Resident. Convert your NRE account to a regular savings account. Failure to update can cause compliance issues later.

Also Read: What Happens to Mutual Funds When Returning to India

5 Common Tax Mistakes NRIs Make on Withdrawal

Mistake 1: Not filing ITR when TDS is deducted

If the TDS exceeds your actual tax liability, you're leaving money with the government. File and claim it back.

Mistake 2: Redeeming everything in one financial year

If you have large gains across multiple funds, redeeming everything in one shot wastes the ₹1.25 lakh LTCG exemption. Spread redemptions across two financial years to use the exemption twice.

Mistake 3: Ignoring the debt fund rule change

NRIs who bought debt funds before April 2023 had long-term benefits. New purchases don't. Plan your debt allocation accordingly. For tax-efficient fixed income exposure, consider GIFT City options.

Mistake 4: Switching funds without calculating tax impact

Every switch is a taxable event. If you're rebalancing a ₹50 lakh portfolio, the tax hit from switches can run into lakhs. Plan switches around the March-April boundary to use exemptions in both years.

Mistake 5: Not providing PAN to the fund house

Without PAN, TDS is deducted at 20% flat even if the applicable rate is lower. Keep your PAN linked and active with all AMCs (Source: Income Tax Act, Section 206AA).

Also Read: NRI Tax Filing Mistakes to Avoid

How to Reduce Tax on Mutual Fund Withdrawals (Legally)

Use the ₹1.25 lakh exemption strategically

Redeem equity funds in December-January. Check your LTCG position. If you haven't used the exemption, book profits up to ₹1.25 lakh before March 31. This is called tax harvesting, selling and immediately repurchasing to reset your cost basis.

Hold equity funds for at least 12 months

The difference between 20% (STCG) and 12.5% (LTCG) is meaningful. On a ₹5 lakh gain, that's ₹37,500 saved just by waiting a few months.

Choose growth plans over IDCW

Dividends are taxed at slab rate annually. Growth plans defer taxation until you redeem and when you do, equity LTCG at 12.5% is usually lower than your slab rate.

Route large investments through GIFT City

For investments above ₹10-15 lakh, the zero-tax benefit of GIFT City funds can save substantial amounts. Use the Belong app to compare NRI FD rates, GIFT City mutual funds, and AIFs side by side.

Claim DTAA benefits and file ITR every year

Even when not mandatory, filing ensures you claim refunds, carry forward losses, and maintain clean records for repatriation.

Track GIFT Nifty movements to time your Indian equity exposure.

Key Takeaway

Tax on mutual fund withdrawals isn't one number - it depends on the fund type, how long you held, and where the fund is domiciled. Equity funds at 12.5% LTCG are reasonable. Debt funds at slab rate are expensive. And GIFT City funds at 0% are the most tax-efficient option for NRIs.

The difference between a well-planned withdrawal and an impulsive redemption can be lakhs in saved tax over a decade.

Many NRIs in our WhatsApp community share their withdrawal strategies and tax filing experiences. If you'd like to learn from their real examples, join the conversation. And if you want to explore GIFT City mutual funds, compare FD rates, or track GIFT Nifty - the Belong app puts it all in one place.

Disclaimer: This article is for informational purposes only. Tax laws change frequently. Consult a qualified tax advisor before making investment decisions. Belong does not guarantee returns and is not responsible for losses based on this information.