Mutual fund investments: How NRIs can save on taxes

India has so far signed DTAAs with 85 countries.
India has so far signed DTAAs with 85 countries.

Summary

  • NRIs can benefit from the double taxation agreements signed between India, other countries.

Here is what helps non-resident Indian (NRI) investors from select countries save tax on mutual fund (MF) investments: Double taxation avoidance agreements (DTAAs). So, how do they benefit from the DTAAs. Read on.

India has so far signed DTAAs with 85 countries. These agreements ensure that no entity faces taxes on the same income in both countries, also known as double taxation. In the absence of such agreements, NRIs who sell stocks, properties, or mutual funds (assets) in India could be subject to tax both here as well as in the foreign country. The DTAA solves this ambiguity by clearly defining what will be taxed in India and what is taxable in the foreign country.

DTAAs signed between India and countries such as US or the UK specify that MF proceeds will be taxed in the Indian tax jurisdiction, while for others like Japan, Korea and UAE, this will happen in the foreign country.

And herein lies the advantage. Some countries such as UAE, Singapore, and Mauritius don’t levy capital gains tax on MFs. So when you sell a MF unit in India, the Indian tax authorities don’t have the right to tax it. Interestingly, if the foreign country where the NRI is residing also does not levy capital gains tax, then they do not have to pay tax in both countries. To be sure, India currently levies 10% capital gains tax for equity investments held for one year or more and 15% for those held for less than 12 months. India also did not charge long-term capital gains from 2004 to 2017.

Mint couldn’t immediately ascertain whether other foreign countries offer this benefit of saving tax under DTAA (see graphic).

(Graphic: Mint)
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(Graphic: Mint)

How it works?

Take the case of the DTAA with UAE, Singapore, and Mauritius. As per the agreement, the provisions on capital gains only mentions taxation of shares and properties in India and the rest will be taxed in the foreign country. Financial experts said that, other than shares and properties (both moveable and immovable), other investments such as MFs, bonds, and derivatives are taxable in the foreign country. They said some countries have additional checks. For instance, NRIs based in Singapore are mandated to repatriate the capital gains from MF investments to that country to get the tax benefit. It is important to check such riders before applying for the benefit.

What about shares?

In most DTAAs, shares are typically taxed in the Indian jurisdiction and thus, get no special benefits.

According to a report by chartered accountancy firm Manohar & Associates, NRIs based in the Netherlands need to pay capital gains tax from listed shares in that country and not India. The only exception is that if the investment in shares is 10% or more of the capital of a particular company, then capital gains from sale of shares of such companies will be taxable in India. In South Korea, capital gains arising out of shares will be mostly taxed in India except when the shares of the Indian company involved do not have principal investments in immovable properties situated in India and if the investors hold less than 5% of the shares. As for most other DTAAs, capital gains tax on Indian shares is taxed in India.

The case for PMS investments are different. Since these are bought and sold by a fund manager in the holder’s account. taxation will depend on what the underlying investments are and where the NRI is based. So if you’re an NRI out of UAE and the fund manager buys stocks, then you are not eligible for capital gains benefit as stocks are taxed in India But if the fund manager buys MF units in the portfolio, then an NRI is eligible for tax benefits under the DTAA between India and UAE .

Category 1 and 2 alternative investment funds (AIFs) also have pass-through structure and will get a similar tax treatment. In the case of category-3, the tax is paid at the scheme level by the AIF itself, so there is no tax benefit for NRIs.

What should you do?

The provisions in the DTAA are difficult to interpret. It is important to consult a qualified tax planner. There are also chances of litigation if undue benefits are availed. It is important to work out the cost-benefit analysis before applying for this benefit under the DTAA. Additionally, there are provisions that prevent NRIs from treaty shopping. This means it might not be a good idea to become an NRI in a particular country for the sole purpose of getting benefits under the DTAA.

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