How Are Mutual Funds Taxed for NRIs?

What is Tax on Mutual Funds?

When you invest in a mutual fund, the Income Tax Department in India recognises a mutual fund as a capital asset.

The government levies tax on any gains you earn on mutual funds based on the fund scheme and period of holdings. The gains are called capital gains. 

Suggested Read - Bonds Vs Debt Mutual Funds: Which One Is Better For NRIs?

Factors to Determine Tax on Mutual Funds

The tax on mutual funds is mainly dependent on the following factors,

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Type of fund

In India, for the purpose of tax, mutual funds are mainly categorized into two types, namely, equity oriented funds and non-equity oriented funds. 

• An equity-oriented fund invest at least 65% of its assets into equity 
• A non-equity-oriented fund allocates not more than 65% of their corpus into equity investments and invests the remaining in government and corporate bonds or other debt instruments.

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Period of holding

The tax levied on the capital gains earned while redeeming funds depends on the holding period of the mutual fund.

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Residential Status

The tax deducted at source is different when you invest as an NRI. However, you can claim the refund by furnishing the necessary documents while filing returns or while redeeming funds. 

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Dividend

At the time of filing your tax returns in India, any receipt of income in the form of distributed dividend by the respective mutual fund shall remain taxable under the head ‘Income From Other Sources’ as per applicable slab rates. Also, you remain eligible for refund on the TDS if your total taxable income level in India is below the threshold limit.

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How Are Profits Generated in Mutual Funds?

As an investor you can earn profits in a mutual fund in the following cases,

• By redeeming the fund at a higher Net Asset Value (NAV) above your previously purchased NAV or 
• By way of receiving dividend income when the mutual fund you invest in receives dividend on their equity investments and distributes the dividend to your (investors) account.

Also, you might receive income when your hybrid or debt fund distributes any interest received on the bonds.

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Taxation of Dividends Offered by Mutual Funds

The fund house distributes dividends into your account by deducting TDS at 20%. And the dividend remains taxable as per the applicable tax slab rate. 

With effect from April 01 2020, receipt of any such dividend shall be taxable under the head ‘Income From Other Sources’ as per the applicable tax slab rate. Hence, you can claim a refund on any such deduction if your total taxable income received in India is below the threshold limit.

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Taxation of Capital Gains Offered by Mutual Funds

As stated above, In India, the mutual funds are generally categorized into equity and non-equity oriented funds. 

Equity-oriented funds include 65% and above investments made in equities and non-equity-oriented funds include hybrid funds that invest not more than 65% of its investments in Equity.

For investments made by non-resident Indians, there is a levy of TDS (Tax Deducted at Source) on the capital gains based on the mutual fund scheme you opt for. 

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Tax Rate For NRIs Investing in Mutual Funds

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Note: No indexation benefit for funds invested by NRIs

Indexation helps adjust the purchase price of your fund to catch up with the inflation rate thereby resulting in lower tax liability when you redeem funds.

* For the debt funds: Investment made before 31.03.23 will continue LTCG tax of 20% & indexation benefit

Find out more about the tax treatment of mutual funds for NRIs here.

Capital Gains Tax For Equity Funds:

The gains realized when redeeming equity-oriented funds are categorized into long term and short term capital gains, and taxed accordingly,

Long Term Capital Gains (LTCG) Tax is levied on your equity fund investments which are held for more than 12 months.The LTCG on your investment is 12.5% (deducted at source) for gains more than Rs 1,25,000.

Short Term Capital Gains (STCG) Tax is levied on your equity fund investments which are held for a period of less than or equal to 12 months. The STCG on your investment is 20% (deducted at source).

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Capital Gains Tax For Debt or Hybrid Funds (Non-equity):

The gains realized when redeeming your investments from a particular fund house that primarily focuses on non-equity investments are categorized into long term and short term capital gains, and taxed accordingly.

LTCG tax on your debt or hybrid investments (non-equity) held for a period of more than 24 months is 12.5% (no  indexation benefit)

For debt funds, investments made after April 1st 2024, the capital gains irrespective of the investment holding period are taxed as per the applicable slab rate.

STCG tax on your debt or hybrid investments (non-equity) is as per applicable tax slab rate. Here, STCG is levied only when the period of holding is less than or equal to 24 months and the TDS is 30%.

Planning to invest in debt mutual funds? Here’s a useful read on which debt funds to choose.

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Securities Transaction Tax (STT) For Equity Mutual Funds

STT is a tax paid on purchasing or selling securities on registered stock exchanges. Regarding mutual funds, only equity-oriented funds attract an STT payment. If you’ve invested in a debt-oriented fund, no STT is liable for it. 

For instance, if you plan to sell a particular equity fund then the rate of STT is 0.001% on the selling price of the equity fund.

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How Do I Avoid Tax On Mutual Funds In India?

Among the different ways to reduce capital gains tax on mutual funds, there are two simple ways to tax on capital gains, namely,

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Tax Harvesting

The Late Finance Minister of India, Shri Arun Jaitley re-introduced LTCG on equity-oriented mutual funds in the year 2018, which states that, any long term capital gain not exceeding INR 1,25,000 does not attract LTCG Tax. 

And you can use this to your advantage by redeeming a portion of equity mutual fund units after a span of 12 months from the date of investment and reinvesting the proceeds back into the same fund.

For instance, if your investment in a particular equity fund amounts to 5,00,000 invested in the month of January 2023 then you can try redeeming a portion of this fund in the month of Feb 2024 given that the gains do not exceed INR 1,25,000 and reinvest the same proceeds back into the fund.

This way you may end up facing lower capital gains tax burdens when you finally decide to redeem the funds.

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Leveraging Losses

When filing your income tax returns in India for the said period, you have the option to capitalize the losses by offsetting any long term capital losses with long term capital gains thereby reducing the capital gains tax burden.

For instance, if you incur loss of INR 25,000 in Dec 2023 from one mutual fund investment that can be offset against any gain realized as part of its redemption in the same financial year thereby reducing the capital gains tax.

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How to Declare Mutual Fund Investments in ITR?

To declare mutual fund investments in ITR you should start by filing ITR 2 Form wherein you are required to disclose any realized capital gains or losses under the head ‘Income From Capital Gains’ and receipt of any distributed dividend is to be disclosed under the head ‘Income From Other Sources’.

It is essential to note that proper filing of ITR is necessary if you are claiming for a refund on the TDS.

Here’s an ultimate guide to fling ITR in India.

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Conclusion

In conclusion, the government of India has levied capital gains tax on mutual funds. While redeeming your funds, tax on NRI investments into mutual funds attracts TDS based on the mutual fund scheme you opt for.

In India, mutual funds are mainly categorized into equity-oriented funds with 65% and above investments into equities and non-equity-oriented funds (debt and hybrid) with not more than 65% equity investments.

By following the tax harvesting process and leveraging capital loss against any gains in the same year, you can now reduce capital gains tax on mutual funds. 

While all this may be hectic to navigate and file. You can hire our NRI tax experts who will help you with tax filings, availing deductions/exemptions and lower the TDS. 

Before selecting equity mutual funds, NRIs should be aware of the tax regulations on such investments, as explained in this post on mutual fund taxation.

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NRI Mutual Fund Taxation: Frequently Asked Questions (FAQs) 

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Is SIP in mutual funds tax free?

No, SIP is just a frequency of payments made by you towards investing in mutual funds. The SIPs attract the capital gains taxes whenever you redeem funds. 

Here, the capital gains tax is levied based on the holding period and the type of investment.

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What happens to mutual funds when you become a resident from NRI?

Your mutual fund's investments remain unaffected, and you don't redeem the funds. 

Since there are no cross-border compliance issues, you will have access to more mutual funds to invest in.

As a resident Indian, when you redeem mutual funds no TDS is deducted.

Also, to receive the redeemed sale proceeds, you must change your bank account from NRO to a resident savings account.

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Should I use an NRO or NRE account for mutual funds?

You can use an NRO or NRE account to invest in mutual funds based on whether you will repatriate your funds abroad.

You can opt for an NRO account to invest the income earned in India while an NRE account to invest the money earned abroad.

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Can I set off my capital asset loss with capital gains made in the same financial year?

Yes, you can offset your loss with the capital gains. A loss arising from a long term capital asset can be set off against only long term capital gains.

However, a loss arising from a short term capital asset can be set off against an STCG or LTCG.

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Are the dividends earned on mutual funds tax-free for NRIs?

No, the dividends earned on mutual funds attract a TDS of 20%. 

It's crucial to understand that the income thus earned is taxable under the heading 'Income from other sources.'

However, you can claim refunds against any such deducted TDS if your taxable income earned in India is below the threshold limit.