For equity-oriented mutual funds, NRIs are subject to a 20% tax on short-term capital gains (STCG) and a 12.5% tax on long-term capital gains (LTCG). The taxation is different for debt mutual funds purchased on or after 1 April 2024, which are always considered short-term in nature and taxed according to the investor’s applicable income slab rate.
For other categories of mutual funds, STCG is taxed at the investor’s slab rate, while LTCG is taxed at a flat rate of 12.5%. If debt mutual funds were acquired before the 1 April 2024 threshold, the gains are taxed under the same STCG and LTCG framework as other mutual funds.
Given these high tax rates, NRIs may hesitate before investing in Indian mutual funds. However, tax liability should not be viewed in isolation. India has signed Double Taxation Avoidance Agreements (DTAA) with several countries, which in some cases allow capital gains to be taxed exclusively in the investor’s country of residence.
Under certain DTAAs, the “residual clause” becomes critical. This clause provides exclusive taxing rights to the country where the seller resides—offering an exemption from capital gains tax in India, so long as the asset is not classified as immovable property or shares of an Indian company.
Also read: For some NRIs, capital gains from Indian mutual funds are tax-free
Case study: Singapore resident gets relief
A recent ruling by the Mumbai Income Tax Appellate Tribunal (ITAT) has clarified the application of this exemption. In the case, the assessee was a non-resident Indian who qualified as a tax resident of Singapore. He had earned short-term capital gains by selling equity mutual fund units and claimed that these gains were exempt from tax in India under Article 13 of the India–Singapore DTAA. However, the assessing officer disagreed and attempted to tax the gains on the grounds that the mutual fund units derived value from Indian assets.
The Mumbai Tribunal ruled in favour of the assessee, citing precedent in a similar case. It held that capital gains from the transfer of mutual fund units should not be covered under Article 13(4), which deals with shares of an Indian company, but rather under Article 13(5), which pertains to “property other than shares.” This distinction is crucial, as it effectively exempts such capital gains from taxation in India under the India–Singapore DTAA. Consequently, the assessee was entitled to tax relief.
This ruling has come as a surprise to many in the investor community. While this exemption has always existed under certain tax treaties, many eligible NRIs are unaware of it and therefore miss the opportunity to claim the benefit.
Also read: Decoding dual taxation: What NRIs need to know for better tax efficiency
Mutual fund houses typically deduct tax at source (TDS) on capital gains from NRIs regardless of treaty applicability, and this deduction is based on standard NRI rates. If excess tax is deducted, the investor must file a tax return in India to claim a refund. If a return is not filed, no refund will be issued.
To avail the exemption, an NRI must meet certain criteria. They must be a tax resident of a country that has a DTAA with India featuring the residual clause—such as Singapore, the UAE, Mauritius, the Netherlands, Spain, and Portugal—and the country of residence must not levy tax on the capital gains in question. The tax relief applies only to capital gains from assets other than Indian immovable property or shares.
Investing via portfolio manager?
In that case, both the interpretation and taxation would have been different. The gains from the sale of units by the portfolio manager, purchased on behalf of the investor, may be subject to tax in such a scenario.
It is therefore essential for NRIs to keep detailed records to prove direct ownership and investment activity. Bank statements should clearly show that the funds were directly invested in mutual fund units and that the sale proceeds were credited directly to the assessee’s account by the fund house.
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NRIs must also ensure that they declare their NRI status to mutual fund houses at the time of investment, understand the applicable tax structures, and take currency fluctuations into account when evaluating investment returns. This ruling serves as a reminder that the tax benefits under DTAA agreements are not automatically granted—they must be properly claimed and supported with appropriate documentation.
Though the exemption has been part of the legal framework, this ruling helps clarify its applicability and confirms that NRIs from select countries can rightfully claim relief. However, the exemption holds only if the country of residence does not impose its own tax on capital gains. With proper planning and awareness, NRIs can legitimately reduce their tax liability on mutual fund investments in India.
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Jigar Mansatta is a chartered accountant based in Jamnagar.