Introduction
Mutual funds offer a good avenue for NRIs to be a part of the Indian growth story. The returns from mutual funds are the same for NRIs and resident Indians. To get the maximum returns on the investments made, it’s important to understand the mutual fund taxation.
In this blog, we will understand the details about NRI investors' eligibility for investing in mutual funds and how the returns for mutual funds are taxed for NRIs.
Eligibility and Investment Rules for NRIs
RBI’s rules and FEMA rules define certain criteria for mutual fund investors. These rules define how you can invest, the documents required, the process to open the bank account, and the rules associated with redemption.
Type of bank account: The first step for investing in mutual funds is opening an NRO or NRE account. This is because mutual fund houses cannot accept investments in currencies other than INR.
Documents required: The next step is gathering the essential documents required for Know Your Customer (KYC). The essential documents required for KYC are: passport copy, PAN card, recent photograph, bank statement, and proof of address.
In addition to this, the investment requires compliance with the Foreign Exchange Management Act (FEMA). To comply with this, NRIs are required to sign a declaration that they will adhere to Indian regulations.
The payments for mutual funds can be made through a cheque or a demand draft. Foreign Inward Remittance Certificate (FIRC) should be accompanied by a copy of the cheque or a demand draft. FIRC is a document issued by a bank as documentation of a foreign money transfer. It tracks the transfer amount in foreign currency, rupees, and the transfer source.
Methods of investing in mutual funds: There are two ways to invest in mutual funds. The first one is through direct investment, and the second one is through assigning a Power of Attorney (PoA).
Direct investment requires NRIs to submit their application and the required KYC documents. This can be with the mutual fund intermediaries (bank, broker etc.) or directly with the Asset Management Companies (AMC). This process may require in-person verification. The NRI will have to visit the Indian embassy in their country of residence with the relevant documentation.
For the second method, NRIs can assign a trusted person back in India with PoA to make investment decisions on their behalf. This requires the signature of both the NRI and PoA on all the KYC documents.
NRIs investors based out of the US and Canada need to sign self-declaration for the Foreign Account Tax Compliance Act (FATCA) forms.
While redeeming the units, the proceeds are credited to either NRE/NRO account after the applicable taxation. Investments redeemed to the NRE account are fully repatriable. This means that you can take back the gains from your Indian mutual funds to your home country. You can repatriate $1 million back to your home country from your NRO account.
Who Qualifies as an NRI for Tax Purposes?
Taxation for NRIs is not dependent on where they stay or earn their income. Rather, it is dependent on the number of days they spend in India.
According to the Income Tax Act, a person is a resident Indian if:
- If s/he has lived in India for more than 182 days in a tax year or
- Have lived in India for more than 365 days in the previous four tax years and have lived in India for 60 days in the tax year in consideration.
The 60-day clause will be replaced by the 182-day clause if the person has left India in the previous year as a crew member or for the purpose of employment outside India.
From the assessment year FY 2021-22, NRIs whose income exceeds Rs. 15 lakhs from Indian sources, the period of 60 days will be replaced by 120 days in clause 2.
Types of Mutual Funds NRIs Can Invest In
NRIs have access to various mutual fund options in India, just like resident Indians.
- Equity Funds: These funds primarily invest in stocks and offer high growth potential but come with higher risks. For example, SBI Bluechip Fund, HDFC Equity Fund, and ICICI Prudential Bluechip Fund are a few equity fund options for NRIs. There are mutual funds tracking the index that trade in the stock exchange. They are called Exchange Traded Funds (ETFs).
- Debt Funds: These funds focus on fixed-income securities like bonds and are suitable for conservative investors seeking stable returns.
- Hybrid Funds: A mix of equity and debt investments, offering balanced risk and reward.
- ELSS (Equity Linked Savings Scheme): Tax-saving mutual funds that allow deductions under Section 80C of the Income Tax Act (old tax regime).
Taxation on Mutual Fund Investments for NRIs
Taxes on mutual funds are based on the nature of the mutual funds. Returns from equity-based mutual funds are treated as capital gains. Debt-based mutual funds are taxed based on an individual's income tax slab.
Taxes apply when the person sells/redeems their mutual fund units. There’s a difference between how mutual funds are taxed for resident Indians and NRIs.
Resident Indians pay taxes on their mutual fund gains when filing their IT returns. For NRIs, mutual fund houses will deduct the TDS when they redeem their mutual funds. NRIs can offset this using DTAA provisions.
Fund Type | Short-term capital gains (STCG) | Long-term capital gains (LTCG) |
|---|---|---|
Equity Mutual Funds | 20% STCG if sold within one year | Gains exceeding Rs. 1,25,000 are taxed at 10% |
Debt Mutual Funds | STCG is taxed according to the income tax slab of the investor | LTCG is taxed according to the income tax slab of the investor |
| Gold/ Silver ETF | STCG is taxed according to the slab rate of the investor if held for a period less than 2 years | LTCG is taxed at 12.5% if held for a period of more than 2 years |
Gold Funds | STCG is taxed according to the slab rate of the investor if held for a period less than 2 years | LTCG is taxed at 12.5% if held for a period of more than 2 years |
Hybrid Mutual Funds | Taxed like equity if equity exposure exceeds 65% | Taxed like debt if equity exposure is below 65% |
Post the union budget of 2024, funds having less than 35% exposure to equity will be treated as debt funds for taxation purposes, irrespective of the holding period. Taxation of debt funds will remain the same until further announcement.
How NRIs Can Claim TDS Refunds Using DTAA
Double taxation can be avoided by NRIs under the Double Taxation Avoidance Agreement (DTAA). To claim a refund:
- Apply for a Tax Residency Certificate (TRC) in the country of your residence.
- Submit Form 10F electronically on the Indian Income Tax website.
- Submit the above documents while filing your Income Tax Return (ITR) in India.
- Completing this process enables NRIs to claim a tax credit for taxes paid in India against their tax liability in their resident nation.
Tax-Saving Strategies for NRI Mutual Fund Investors
- Invest in ELSS Funds: ELSS provides tax benefit of up to ₹1.5 lakh under Section 80C with a 3-year lock-in and potential for equity growth. The tax benefit of ELSS funds is only available under the old tax regime.
- Leverage DTAA Benefits: You can claim tax relief under DTAA to avoid double taxation on your mutual fund gains.
- Plan Holding Periods: Keeping your equity funds for more than one year lowers the taxation burden. Planning redemption and re-investment of mutual fund gains can lower taxation. Consult your financial advisor for specific planning to leverage the tax benefits.
NRI Mutual Fund Tax Examples & Case Studies
Case Study 1: Equity Mutual Fund
Let us understand it with an example: An NRI invests ₹10 lakh in an equity fund. After two years, the value grows to ₹15 lakh. LTCG of ₹5 lakh will be taxed at 12.5% after the ₹1.25 lakh exemption. Total tax payable: ₹46,875.
Case Study 2: Debt Mutual Fund
Let us understand it with an example: An NRI invests ₹10 lakh in a debt fund, which grows to ₹14 lakh in four years. The amount of tax imposed on the gains will be ₹4 lakh. The NRI does not have any other earnings in that financial year, and he uses the new income tax slab. In that he will be taxed at 5% for gains above ₹3 lakhs. The total tax payable is: 5% of 1 lakh, i.e., ₹5,000. Hence the additional amount deducted by the mutual fund will be returned once files his IT return.
How NRIs Can File Taxes on Mutual Fund Gains
For NRIs, TDS gets deducted when they redeem their mutual fund units. NRIs can file their IT returns using the process mentioned to claim back their money.
- Filing Procedure: NRIs are required to file ITR-2 if they receive capital gains from mutual funds. The form is designed for those who have income from capital gains, foreign assets, or multiple house properties. The filing can be made online through the income tax department's e-filing portal.
- Documents Needed: You need to submit Form-16A and TDS certificate against the TDS they have deducted against the gains.
Legal Compliance & Common Tax Challenges for NRIs
FATCA Compliance
The Foreign Account Tax Compliance Act (FATCA) is a law mandating US and Canada residents to report their foreign income. FATCA compliance makes paperwork more cumbersome for US and Canada-based NRIs. Currently only 8 AMCs accept investments from USA and Canada NRIs.
- Aditya Birla Sun Life Mutual Fund
- SBI Mutual Fund
- UTI Mutual Fund
- ICICI Prudential Mutual Fund
- DHFL Pramerica Mutual Fund
- L&T Mutual Fund
- PPFAS Mutual Fund
- Sundaram Mutual Fund
FEMA Regulations
FEMA regulations may impose restrictions on certain mutual fund schemes to accept funds from NRIs.
Residency Change Impact
If NRIs become residents in a financial year, tax rules for residents will apply.
Conclusion
For NRIs, mutual fund investments may seem overwhelming due to compliance around it. Through proper planning and professional Mutual fund investments are a good way for NRIs to be a part of the Indian growth story. But they carry certain tax implications and compliance. NRIs can cut down their tax burden through proper planning. Consulting a tax professional will reduce the hurdles and taxation while maximising the returns from their investments.
