Investing in mutual funds is a popular option for many Non-Resident Indians (NRIs) seeking to diversify their investment portfolio in India. However, it’s crucial to understand the tax implications associated with mutual fund investments as they can significantly impact the overall returns. In this comprehensive guide, we will delve into the intricacies of mutual fund taxation for NRIs, covering various aspects such as capital gains tax, dividend distribution tax (DDT), tax residency certificate (TRC), and other important points.
1. Capital Gains Tax:
Gains from the sale of mutual fund units are subject to capital gains tax. The tax treatment depends on the holding period of the units.
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Short-term capital gains (STCG):
If an NRI holds mutual fund units for up to 3 years and sells them, the gains are treated as STCG and are taxed as per the applicable income tax slab rates in India. It means the gains will be added to the NRI’s total income and taxed at the regular income tax rates, which can range from 0% to 30% depending on the income slab.
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Long-term capital gains (LTCG):
If an NRI holds mutual fund units for more than 3 years and sells them, Authorities treat the gains as LTCG. For equity-oriented mutual funds, which include funds with more than 65% allocation to equities, The authorities tax LTCG at a flat rate of 10% without indexation, if the gains exceed INR 1 lakh in a financial year. This means that the NRI can avail of a tax exemption on gains up to INR 1 lakh, and the gains exceeding that will be taxed at 10%. For debt-oriented mutual funds, which include funds with less than 65% allocation to equities, The authorities tax LTCG at a rate of 20% while providing indexation benefits. Indexation helps in adjusting the purchase price of the units with the inflation index, reducing the overall tax liability.
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2. Dividend Distribution Tax (DDT):
DDT is a tax levied by mutual fund companies on the dividends declared and distributed to the investors. The tax treatment of dividends for NRIs has undergone changes in recent years.
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Equity-oriented mutual funds:
In the past, dividends paid by equity-oriented mutual funds to NRIs were subject to DDT at the rate of 10%, plus an additional surcharge and health and education cess, before distributing them to the NRI investors. However, since April 1, 2020, mutual fund companies are not liable to pay DDT, and instead, the dividends are taxable in the hands of the investors as per their applicable income tax slab rates in India. This means that the NRI will have to pay tax on the dividends received based on their income slab rates, which can range from 0% to 30%.
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Debt-oriented mutual funds:
In the past, dividends paid by debt-oriented mutual funds to NRIs were subject to DDT at the rate of 25%, plus an additional surcharge and health and education cess, before distributing them to the NRI investors. However, since April 1, 2020, mutual fund companies are not liable to pay DDT, and instead, the dividends are taxable in the hands of the investors as per their applicable income tax slab rates in India. This means that the NRI will have to pay tax on the dividends received based on their income slab rates, which can range from 0% to 30%.
3. Tax Residency Certificate (TRC):
- To avoid paying taxes on the same income twice, NRIs investing in mutual funds in India can make use of the Double Taxation Avoidance Agreement (DTAA) between India and their country of residence. To avail of the benefits of DTAA, NRIs need to obtain a Tax Residency Certificate (TRC) from the tax authorities in their resident country. The TRC serves as proof of residency and helps in determining the taxability of mutual fund investments in India based on the tax treaty between the two countries.
4. Other Important Points:
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Tax implications on switching or redemption of mutual funds:
NRIs should be aware that switching or redeeming mutual funds is treated as a sale and can trigger capital gains tax implications, as discussed earlier. It’s important to factor in the tax implications while making any such transactions.
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TDS (Tax Deducted at Source):
As per Indian tax laws, At the time of redemption of units, mutual fund companies must deduct TDS on capital gains earned by NRIs. The TDS rate is 20% for LTCG and 15% for STCG, and it may vary based on the type of mutual fund and the applicable tax treaty. NRIs can claim a refund of excess TDS deducted while filing their income tax return in India.
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Reporting of mutual fund investments in Income Tax returns:
NRIs must report their mutual fund investments in their income tax return in India. They need to provide details of the mutual fund units held, capital gains earned, and taxes paid or deducted, if any, in the appropriate sections of the income tax return form.
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Tax implications on Systematic Investment Plans (SIPs):
Every SIP installment is classified as a distinct investment with its own holding term for capital gains tax calculations, which NRIs investing in mutual funds through SIPs need to be aware of. Therefore, the capital gains tax implications will be based on the holding period of each SIP installment, and NRIs need to factor in the same while calculating their tax liability.
Conclusion
NRIs who invest in mutual funds in India must be aware of the tax repercussions of their choices. It’s important to understand the capital gains tax, and dividend distribution tax, obtain TRC if required, and be aware of other important points such as TDS and reporting of investments in the income tax return. Seeking professional tax advice and staying updated with the latest tax laws and regulations can help NRIs make informed investment decisions and optimize their tax liabilities on mutual fund investments in India.