Tax Benefits Of Mutual Funds For NRI Investors

Mutual Funds in India have emerged as a popular investment option for both retail and institutional investors. Essentially, a Mutual Fund pools money from multiple investors to invest in a diversified portfolio of stocks, bonds or other securities. This pooling of resources allows the individual investors to access a variety of assets, which might be difficult to achieve independently due to high capital requirements or limited knowledge.

In India, the Mutual Fund industry has seen exponential growth over the recent years, driven by a rising middle class, increased financial literacy and supportive regulatory frameworks. The Indian Mutual Fund space offers a wide range of products catering to varied investment objectives and risk appetites, from Equity and Debt Funds to hybrid and solution-oriented schemes. 

Mutual Funds provide diversification, professional management, liquidity and attractive returns. Additionally, Systematic Investment Plans (SIPs) have become a favoured approach among Indian investors for building wealth over the long term, demonstrating the growing sophistication and maturity of the Indian Mutual Fund market.

For Non-Resident Indians (NRIs), Mutual Funds in India offer an attractive investment avenue. These investments not only provide exposure to the Indian growth story but also bring along certain tax advantages. It is crucial for NRIs to understand the tax implications to make the most out of these opportunities. This blog simplifies the complexities surrounding NRI taxation in Mutual Funds. 

Investing in Indian Mutual Funds

NRIs can invest in Indian Mutual Funds under the guidelines of the Foreign Exchange Management Act (FEMA). To begin, they need to open either a Non-Resident External (NRE) or Non-Resident Ordinary (NRO) Account and complete the Know Your Customer (KYC) formalities. It is important to note that some Mutual Funds may have restrictions for NRIs from USA and Canada due to the Foreign Account Tax Compliance Act (FATCA), though there are options available under certain conditions.

Currency Appreciation Benefit

NRIs also stand to benefit from the currency appreciation. A stronger Rupee against the currency of their resident country/ies can enhance the returns from these investments. 

Tax implications for NRIs

1. Tax Deducted at Source (TDS)

• Equity Mutual Funds

Short-term (holding period ≤ 1 year): TDS at 15%

Long-term (holding period > 1 year): TDS at 10%

IDCW Option: TDS at 20%

• Other Funds

Short-term: TDS at 30%

Long-term (Listed): 20% with indexation; (Unlisted): 10% without indexation

IDCW Option: TDS at 20%

NRIs can claim a refund if their tax slab is lower than the TDS rate when filing returns.

2. Capital Gains Tax

• Equity Mutual Funds

Short-term gains taxed at 15% Long-term gains over Rs 1 lakh are taxed at 10% without indexation

• Other Funds

Short-term gains taxed as per the income tax bracket Long-term gains taxed at 20% with indexation (Listed) or 10% without indexation (Unlisted)

3. Tax Return of Income

NRIs need not file a tax return if their income in India consists solely of investment income or long-term capital gains, provided TDS has been deducted. However, filing returns can be beneficial if they fall into a lower tax slab, as they may be eligible for a refund.

4. Taxation of dividends

Dividends from Mutual Funds are taxed as per the applicable tax slab rates for the NRIs.

Tax benefits

 The Double Taxation Avoidance Agreement (DTAA) is a bilateral treaty designed to protect against the risk of double taxation, where the same income is taxed in two different countries. This is particularly relevant for Non-Resident Indians (NRIs), who might earn income that is subject to tax, in India and the country of residence. The DTAA ensures that the income earned from the investments made in India is taxed only in one country, based on the specific terms outlined in the agreement.

 For NRIs, this treaty provides an opportunity to offset taxes paid in India against their tax obligations in the country of residence. To benefit from DTAA, NRIs need to submit certain documents to the entity responsible for tax deduction (deductor). These documents typically include a Self-declaration, an Indemnity Form and Proof of Citizenship or Person of Indian Origin (PIO) status.

 Separately, Section 80C of the Indian Income Tax Act offers tax benefits to individuals investing in specific savings instrument/s. One such instrument is the Equity Linked Savings Scheme (ELSS), which allows for a deduction from the taxable income. The maximum deduction available under Section 80C, including investments in ELSS, is Rs <1,50,000>. This provision enables taxpayers to reduce their overall tax liability by investing in ELSS and other eligible financial products.

Key terminologies

• Capital Gains Tax: A tax levied on the profit made from selling assets like property, stocks or bonds. It is calculated by subtracting the purchase price from the selling price.

• Tax Deducted at Source (TDS): A system in which tax is automatically deducted from the income (like salary or interest payments) at the time of payment. It is a form of advance tax payment.

• Indexation: A method to adjust the purchase cost of an asset. This is particularly used in calculating tax on long-term capital gains, as it effectively reduces the taxable amount by accounting for inflation.

• Income Distribution Cum Capital Withdrawal (IDCW): In Mutual Funds, IDCW is an option where profits are distributed to investors as dividends. This can be a periodic payout of the fund's income or capital gains. 

Conclusion

 Understanding the tax implications of Mutual Fund investments in India is essential for NRIs. These insights help in making informed decisions, ensuring compliance with the tax laws and optimising returns. Staying updated on the tax laws, especially the provisions of DTAA, is crucial for effective investment planning.