As an NRI, you might be wondering about your tax obligations on capital gains from Indian mutual funds. The answer isn't always straightforward, as it depends on several factors, including the type of mutual fund, the holding period, and the country where you reside. Here's a breakdown to help you navigate the complexities.

Taxability of Mutual Fund Investments for NRIs

Generally, NRIs are subject to Indian tax laws on income earned or accrued in India, which includes capital gains from mutual funds. Similar to resident Indians, NRIs have to pay taxes on their mutual fund profits, which are primarily divided into two categories: Short Term Capital Gains (STCG) tax and Long Term Capital Gains (LTCG) tax. Tax Deducted at Source (TDS) is also applicable.

Determining the Holding Period

The holding period is crucial in determining the applicable tax rate. For equity mutual funds, if the units are held for less than one year, the gains are considered short-term. If held for more than one year, the gains are long-term capital gains. For debt mutual funds, the threshold is generally three years. If held less than 3 years, the gains are considered short term and if held for more than 3 years, the gains are considered long term.

Capital Gains Tax Rates

• Equity Mutual Funds:
  • Short-Term Capital Gains (STCG): STCG from equity mutual funds are taxed at a flat rate. For NRIs, capital gains from equity mutual funds will be considered short-term capital gains (STCG) if the mutual funds are sold on or before the completion of one year. The STCG from equity mutual funds will be taxed at 20% plus cess. These new rules are applicable to equity mutual funds sold on or after July 23, 2024.
  • Long-Term Capital Gains (LTCG): LTCG from equity mutual funds exceeding ₹1 lakh in a financial year are taxed at 10%. Capital gains from equity mutual funds will be considered long-term capital gains (LTCG) if they are sold after holding them for a year. The LTCG from equity mutual funds will be taxed at 12.5% plus cess. These new rules will apply to equity mutual funds sold on or after July 23, 2024.
• Debt Mutual Funds:
  • Short-Term Capital Gains (STCG): Short-term capital gains are taxed as per the NRI's applicable income tax slab.
  • Long-Term Capital Gains (LTCG): Long-term capital gains are taxed at 20% with indexation benefits.

Tax Deducted at Source (TDS)

TDS is deducted on capital gains at the time of redemption. The rates vary based on the type of fund and holding period.

• For equity funds, TDS is 15% on short-term gains and 10% on long-term gains.
• For debt funds, TDS is 30% on short-term gains and 20% on long-term gains with indexation.

Double Tax Avoidance Agreement (DTAA)

India has signed Double Tax Avoidance Agreements (DTAA) with several countries. These agreements prevent NRIs from being taxed twice on the same income – once in India and again in their country of residence. Under DTAA, if you've already paid tax on your mutual fund returns in India, you can often claim a tax credit or deduction for the same income in your home country. The Mumbai Income Tax Appellate Tribunal (ITAT) has ruled that capital gains earned from Indian mutual fund units by NRIs will not be taxed in India.

Recent Tax Rule Changes

It's important to stay updated with the latest tax rule changes. For instance, from FY 2024-25, the capital gains taxation rules were revised for all asset classes, including mutual funds. The tax rate for short term capital gains tax on equity mutual funds has increased from 15% to 20%. Additionally, the long term capital gains tax on equity mutual funds has risen from 10% to 12.5%.

Do you need to file a tax return?

Whether you need to file a tax return depends on your total income in India and the applicable tax laws. If your income exceeds the basic exemption limit or if TDS has been deducted, filing a return is generally required.

Conclusion

As an NRI, understanding the tax implications of your mutual fund investments is crucial. While the rules can seem complex, paying attention to holding periods, fund types, and DTAA benefits can help you optimize your tax liability. Staying updated on the latest tax law changes and seeking professional advice when needed is also highly recommended.