In today’s times when there’s no dearth of investment options, mutual funds continue to be an excellent investment option for wealth building. They offer numerous advantages, including diversification, easy liquidity, and the potential for high returns.
Moreover, they are managed by fund managers, making them a good option for domestic and NRI investors who want to capitalise on investment opportunities in India. However, the tax structure for mutual funds differs for domestic and NRI investors, which can affect overall returns. In this article, we will discuss the tax implications that NRI investors must consider before investing in mutual funds in India.
Investing in Indian Mutual Funds
NRIs are allowed to invest in Indian mutual funds through the Foreign Exchange Management Act (FEMA) guidelines. To do so, they need to open either a Non-Resident External (NRE) or Non- Resident Ordinary (NRO) account and complete the necessary Know Your Customer (KYC) formalities.
TDS on NRI Income
The Indian Income Tax Act of 1961 outlines specific taxation guidelines for NRI investors who earn income outside of India, making them subject to a different set of rules and benefits. The Income Tax Department mandates that tax be deducted at source (TDS) on incomes earned by NRIs in India, including interest on deposits, rental income, and capital gains. For instance, TDS on short-term capital gains from equity investments is 15%, while it is 10% for long-term capital gains.
Equity-oriented Mutual Funds
If an NRI holds mutual fund units for less than a year (short-term), they will be charged a 15% tax (STCG) on their capital gains. If the units have been held for over one year, a 10% tax (LTCG) will be levied if the gains exceed ₹1 lakh per year.
Debt-oriented Mutual Funds
If the debt fund units are sold within three years of purchase, their returns are treated as short-term capital gains and taxed at the applicable income tax slab rate. In the case of long-term holdings (units held for over three years), the gains are taxed at 20% with the benefit of indexation.
Shares and Equity Investments
NRI investors who trade in shares listed on Indian stock exchanges are taxed based on their investment’s holding periods. Short-term capital gains (held for less than a year) are taxed at 15% while long-term capital gains (held for over one year) exceeding ₹1 lakh per financial year are taxed at 10%.
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Tax on Investment Income
According to the guidelines laid down Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI), NRIs can invest in various instruments in India under FEMA. This includes investments like fixed deposits (FDs), shares, mutual funds, real estate, etc., all of which have varying tax implications. For instance, NRI mutual fund investors will be taxed based on the fund type and holding period of their investment.
NRIs can also benefit from the Double Taxation Avoidance Agreement (DTAA) that India has with several countries. This agreement ensures that NRIs are not subject to double taxation on the same income in both India and their country of residence. They can utilize DTAA benefits to reduce their tax liability, particularly on interest income, dividends, and capital gains.
The writer is CEO of Bankbazaar.com