You’ve Checked the Returns - But Have You Checked the Taxes? (Part 3 - Taxation for NRIs)

Before we dive deeper into taxation for NRIs, here are the links to Part 1 and Part 2 of the series, which cover the basic concepts that will be useful in understanding NRI Taxation as well.

Part 1: You’ve Checked the Returns - But Have You Checked the Taxes? (Part 1 - The Basics)

Part 2: You’ve Checked the Returns - But Have You Checked the Taxes? (Part 2 - Making Smarter Choices)

What Stays the same for NRIs?

Most of the rules and parameters for taxation of mutual funds, that we have covered in Part 1 stay the same for residents and NRIs. So, if you've read Part 1, you already understand 70% of the mechanics.

Here is a list of things that stay the same for NRIs:

• The criteria for assessing the type of fund (equity, debt or hybrid)

• The holding period criteria for deciding whether an investment is short-term or long-term

• The exemption of ₹1.25 lakh per financial year on long-term capital gains from equity shares and equity-oriented mutual funds

• Taxation of distributions under the IDCW payout option

• Filing income tax returns in India - you have to file it if you redeem or receive income from mutual funds

• Tax rates applicable for each category (summarized in the table below)
  
  
  

  Categories	Purchase	Holding	Tax Rules
  Equity, Aggressive Hybrid, Equity FoF*	Any	> 12 months	STCG: 20% LTCG: 12.5% Exemption: Up to 1.25L**
  Debt, Conservative Hybrid	Post Apr 2023	NA	STCG: Slab LTCG: Slab Exemption: None
  Debt, Conservative Hybrid	Pre Apr 2023	> 24 months	STCG: Slab LTCG: 12.5% Exemption: None
  Balanced Hybrid***	Any	> 24 months	STCG: Slab LTCG: 12.5% Exemption: None
  Other Funds (e.g. gold, silver, overseas)	Any	> 24 months	STCG: Slab LTCG: 12.5% Exemption: None

  
  

  
  * an Equity Fund of Funds is defined as a fund of funds which invests 90% of its money in the underlying funds and the underlying funds invest 90% of their money in Indian domestic equities. If not, it will be classified under ‘other funds’

  
  ** While tax on long term capital gains up to INR 1.25lakhs is exempt, it is still included in the income for determining your tax slabs (this becomes crucial especially if the investor’s income is on the verge of crossing the limit for surcharge). Exemption can also be claimed under section 54F on capital gains from sale of mutual funds, if the proceeds are used to buy a house (subject to various conditions). Please consult your tax advisor before decision making

  
  *** Based on our interpretation of the various tax sections (including Section 50AA). Alternate interpretations are possible – please consult with your tax advisor

  
  

What Changes for NRIs?

Here’s where NRI taxation diverges from residents:

Tax Deducted at Source (TDS) on Redemption

For NRIs, mutual fund houses deduct tax at source on capital gains - whether short-term or long-term. What this means is that the mutual fund house would retain the tax payable on your capital gain, deposit that tax with the government (for which you can claim credit while filing your returns) and remit the remaining amount to you. This affects cashflow planning, because your redemption proceeds are net of tax. Tax is deducted similarly on the distributions made by mutual funds.

For example, Mr. X (an NRI) redeemed his equity oriented mutual funds, with a holding period of less than 12 months (hence classifying as short term capital gain). He had purchased those units for ₹10 lakhs and sold them for ₹13 lakhs.

Note: For certain categories of mutual funds, tax rates are based on the investors’ slab rates. Since fund houses cannot reliably estimate slab rates for each investor, they sometimes deduct taxes at 30% (plus cess and surcharge), unless a proof of lower income is submitted by the investor to the fund.

TDS on Distributions

While distributions made under the ICDW payout option are taxable as per an individual’s slab rates, the TDS is deductible at 20% (plus applicable surcharge and cess) by the fund house*. Please note that tax liability arises on dividends re-invested also (and not just dividends paid out).

* The TDS rate of 20% is based on our interpretation of the applicable rules and common market practice. However, there could be an alternate interpretation for a 30% deduction as well.

Repatriation Rules

NRIs typically have NRE, NRO or FCNR accounts. Foreign earnings are invested through NRE accounts and the return on those investments are fully repatriable/transferrable to the foreign (resident) country. NRO accounts are for investing money earned by NRIs from domestic (Indian) source – there are certain limits/restrictions on money that can be repatriated/transferred abroad from these accounts.

Depending on the source of funds and requirement for repatriation, the type of account must be chosen.

Claiming Tax Credit

If you are a tax resident of a foreign country, you are likely to pay taxes on the same mutual fund income in that country as well (depending on the tax rules of that country), which could lead to double taxation on the same income (since tax is chargeable on that income in India as well).

However, if India has signed a Double Taxation Avoidance Agreement (DTAA)* with your residing country, you can claim credit for the taxes paid in India (subject to calculation mechanism described in the DTAA) or have tax deducted at a lower rate (applicable for certain countries). Please do consult your tax advisor for available tax credits, and for requisite & timely filings.

* In simple terms, DTAA is an agreement between 2 countries, which lays down the mechanism for taxability of income for people (or entities) who are liable to pay taxes in 2 countries. The main purpose of DTAA is to avoid or minimise instances where a person has to pay double tax on the same income (due to his dual tax residency).

Additional Considerations for US Tax Residents

If you are a tax resident of the US – that is if you are a US citizen or a green card holder, or fulfil the ‘substantial presence test’ (simply put, if you are required to file your tax returns in the US), certain additional rules and conditions impact your mutual fund journey in India.

Tax on Unrealized Mutual Fund Gains due to Passive Foreign Investment Companies (PFIC) Rules

Indian Mutual Funds classify as ‘PFIC’ under US regulations. Due to this classification,  US residents have different tax implications on their Indian mutual fund income. They have to elect between 3 taxability options available to them and fill Form 8621. The 3 options are:

1. Declare unrealized gain on mutual fund investments as income and pay tax on it every year. In simple terms, let’s say you purchased Indian mutual funds worth ₹10 lakhs. At the end of the year, the value of these mutual funds is ₹12 lakhs. In the US, you will have pay tax on ₹2 lakhs unrealized gain (even if you are not redeeming the units) for the year. Assume the value increases to ₹13lakhs at the end of Year 2, then you will have to pay tax on ₹1 lakh. Every year until you redeem, you will have pay tax in the US on the unrealized gain for that year.

2. Qualified Election Fund – Currently not a practical route for Indian mutual funds – so we are not discussing in detail.

3. Default option – If no option is elected or no form is filed during the holding period, the IRS would spread your realized gain over the holding period, charging the highest tax rate for each year and an interest for late payment of taxes.
   Continuing with the example above, lets assume you sold the mutual funds for ₹13 lakhs at the end of Year 2 (but did not elect the first option). In this case, your total gain (₹3 lakhs), would be split in 2 years (₹1.5 lakhs each). Tax will be charged on this at the highest rate in force (currently 37%). You will also be charged interest for late payment of tax for Year 1 (since you are paying your entire tax in Year 2 at the time of redemption of your units)

What this means for you if you are a US investor? – In simple terms, you will have to pay taxes in the US each year on your unrealized gain from Indian Mutual Funds (the 1st option above, which is the most feasible), which may impact your liquidity each year.

There will also be a timing mismatch in terms of taxes deducted in India (which will be at redemption) and in the US (every year). This may lead to complications in claiming/utilizing tax credits. Two such complications are:

• The entire tax deducted in India would be in the year of redemption, while the US taxes are payable each year. So until the year of redemption, you would not get any Indian tax credit and US tax liability will have to be borne by you

• Tax deducted in India at redemption will be on the entire holding period gain on the mutual fund, which could be much larger than the unrealized gain in that year taxed in the US. So you may not be able to fully utilize your Indian tax credit.

This makes Indian mutual funds less attractive for US investors relative to direct stock investing or Portfolio Management Services (PMS).

To clarify, the tax treatment as per Indian laws would be the same as discussed above; however, there would be tax implications in the US that could impact the investment decision and hence we are covering the basic PFIC rules here.

As you can imagine, there are lot of complex things happening here involving the Indian and US tax laws, so please consult your tax advisor before any decision making.

Restriction on investments

Due to extensive reporting required by AMCs under FATCA (which is a US regulation for foreign account reporting), some AMCs restrict investments by US residents in their schemes completely or require offline forms to be filled. These restrictions sometimes apply to Canadian residents as well.

Note: The article above covers taxation mainly from the perspective of Indian laws, please check the laws of your residing country as well for tax treatment under local regulations. Further, please note that the tax provisions mentioned above are based on the prevailing law as of November 2025 and assumes the investments will be sold after 1 April 2025. Tax provisions are open to interpretation so please consult your tax advisor before any decision making.