As an NRI, do I need to file a tax return for Indian mutual fund capital gains?

I have been living and working in Australia since 2015. I have an NRE account in India. I only have investments in mutual funds in India and NRE interest income. I’m redeeming units of a flexi cap mutual fund in which I had invested in 2019. Is it true that if tax deducted at source (TDS) applied on capital gains, I don’t have to file a tax return in India?

- Name withheld on request

Under the Indian Income Tax Act, 1961, the classification of capital gains is determined by the holding period of the asset. Since you have held the mutual fund units since 2019, they will be regarded as long-term capital assets, and any gains from their redemption will be treated as long-term capital gains (LTCG).

Flexi cap mutual funds are classified as equity funds. Accordingly, LTCG exceeding ₹1,25,000 from the sale of these units will be taxed at 12.5% plus surcharge and cess. Unlike a resident individual, you are not entitled to adjust such gains against the basic exemption limit, even if the total capital gains are below ₹1,25,000.

The law also has special provisions for certain types of income earned by non-resident Indians (NRIs). Under these, if an NRI’s total income in India comprises only long-term capital gains from the transfer of a ‘foreign exchange asset’ and the applicable TDS has been correctly deducted and deposited, the individual is not required to file an income tax return in India.

Interest earned on an NRE account is exempt from income tax and is excluded from the assessee’s total income, thereby leaving long-term capital gains as your only source of income in India.

What is a ‘foreign exchange asset’?

The term ‘foreign exchange asset’ is expressly defined in the Income Tax Act to include shares of an Indian company, debentures of an Indian public limited company, deposits with an Indian public limited company, and central government securities, provided they are purchased with convertible foreign exchange.

Mutual fund units are not included in this definition, even if they were bought using convertible foreign exchange. Therefore, the exemption from return filing in such cases does not extend to capital gains arising from redemption of mutual funds.

Also, under the India-Australia Double Taxation Avoidance Agreement (DTAA), capital gains from the redemption of mutual fund units remain taxable in India. The treaty does not give exclusive taxing rights to Australia or provide an exemption in this regard. Consequently, LTCG from such redemption will be taxed at 12.5% plus surcharge and cess in India.

This means will need to file an income tax return in India for the relevant assessment year, disclose the gains from the redemption of your mutual fund units and, if applicable, claim a refund for any excess TDS.

Harshal Bhuta is partner at P. R. Bhuta & Co. Chartered Accountants.