NRI's - Tax Implications Of Mutual Fund Investments
What are the investment choices for NRI's?
NRI's can have bank deposits on which they can earn Indian rupee interest (NRO deposit, not repatriable 30% TDS) or Libor linked interest (NRE, FCNR deposits, fully repatriable, interest fully exempt from tax). Bank deposits are still the most popular form of investment for NRI's.
If the objective is to earn the higher interest rates (Interest rates in Indian markets are higher than the international rates that are Libor-linked) they are primarily interested in debt-oriented products.
Debt products
• Government sponsored saving schemes like Post office NSC - Not eligible to invest
• RBI Savings Bonds - Not eligible to invest
• Government Security - Eligible. Have to open SGL II account. Interest taxable. TDS applies
• Bank deposit - Eligible. Have to obtain PAN number. TDS applies on taxable NRO deposits
• Corporate Bonds - Eligible. Low liquidity. Interest taxable. TDS applies
• Debt Mutual Funds - Eligible. High liquidity. Dividend (subject to DDT) exempt from tax. Capital gains subject to indexation (TDS applies)
Equity products
NRI's are eligible to invest directly in equity markets or through mutual funds. The tax implications are the same, except for short term capital gains. Dividend is exempt from tax, long term capital gains are exempt. Short-term capital gains are taxable at 10%+sc+cess, effective 11.22% for direct investment and equity funds, but in the case of equity funds, the short term capital gain is subject to TDS at 33.6%, even though the applicable tax is much lower at 11.22%
Why mutual funds?
a. Range of products - from Liquid fund, to FMP, MIP and equity and FMP, mutual funds have them all. They can choose the product they are most comfortable with
b. Tax exempt income - Mutual fund dividends are fully exempt from tax. No TDS
c. Benefit of Indexation - They can choose a growth option in a debt fund, so that their long term capital gains can be indexed. The actual long term capital gain is thus drastically reduced
d. Procedural Ease - NRI's worry the most about the procedures for PAN and returns, and the hassle of getting the income tax refund. They will love a mutual fund product that gives them the return, which is tax exempt
e. Facility to re-invest dividend - In a mutual fund product, they can choose a dividend re-investment option that enables them to deal with payouts easily, without having to worry about small amounts getting credited into bank accounts
Which mutual fund products would appeal to the NRI's who are currently investing in fixed deposits?
a. Since the NRI's are comfortable with fixed income products, the FMP would appeal to them. The points to note are as under:
- It is important to check if there is a rollover option, so the investor knows
- Every FMP does not have both growth and dividend options. If only one option is available, tax implication is to be explained. If it is long-term capital gain (growth option, FMP>1yr), 10% LTCG tax (effective 11.22%) will apply as TDS, after indexation benefit. If it is a short term capital gain, 33.6% tax and TDS will apply. If it is a dividend option, the DDT will apply (13.07% effective)
b. If a NRI chooses to invest in debt mutual funds, a growth option is better than dividend option if the holding period is over 1 year. Only 10% LTCG (effective 11.22%) will apply. A dividend distribution will be subject to 13.07% effective DDT. If the holding period is less than 1 year, dividend option is better than growth option, because STCG is taxed at higher rates than the DDT
c. If the NRI chooses equity funds, the benefit is highest for long term holding. The dividends are tax exempt. So are LTCG. No TDS on long term capital gain
d. The short term holding in equity funds, is most unattractive. Though STCG is taxable at 11.22% effective, applicable TDS is 33.6%. If the NRI chooses a dividend reinvestment option, he can effectively earn tax-free returns from the equity investment
e. If the NRI likes some investment in debt and some in equity, the Child Care (Gift) Plan and the Balance fund are tax-advantaged options. They are equity-oriented funds, therefore subject to same tax treatment as equity funds in (c) above. But they have about 40% in debt instruments, if that gives the investors the comfort
How can NRI's protect their investment from currency fluctuations?
It is possible to buy a forward cover against the mutual fund investments, from a bank. A lien will be marked on the investments, and a cover for exchange risk can be purchased.
Can the money be repatriated?
As long as the investment is from a NRE account, and the banker certificate is attached to the application, the funds are fully repatriable. Only investments from NRO accounts are non-repatriable.
Surcharge for Resident Indians, Domestic companies and NRIs:
For Individuals, HUF, BOI and AOP, 10% surhcarge on tax payable if income exceeds Rs. 10 lakhs
For others including corporate bodies, 10% surcharge on tax payable
Education Cess
Education Cess is levied at the rate of 3% calculated on tax payable plus surcharge
A higher TDS is done on equity funds, despite the actual tax rate being low, due to the relevant tax law on TDS not having altered, even in this budget (2005-06). NRI's have to claim a refund on this TDS when they file their tax return.
NRI's can have bank deposits on which they can earn Indian rupee interest (NRO deposit, not repatriable 30% TDS) or Libor linked interest (NRE, FCNR deposits, fully repatriable, interest fully exempt from tax). Bank deposits are still the most popular form of investment for NRI's.
If the objective is to earn the higher interest rates (Interest rates in Indian markets are higher than the international rates that are Libor-linked) they are primarily interested in debt-oriented products.
Debt products
• Government sponsored saving schemes like Post office NSC - Not eligible to invest
• RBI Savings Bonds - Not eligible to invest
• Government Security - Eligible. Have to open SGL II account. Interest taxable. TDS applies
• Bank deposit - Eligible. Have to obtain PAN number. TDS applies on taxable NRO deposits
• Corporate Bonds - Eligible. Low liquidity. Interest taxable. TDS applies
• Debt Mutual Funds - Eligible. High liquidity. Dividend (subject to DDT) exempt from tax. Capital gains subject to indexation (TDS applies)
Equity products
NRI's are eligible to invest directly in equity markets or through mutual funds. The tax implications are the same, except for short term capital gains. Dividend is exempt from tax, long term capital gains are exempt. Short-term capital gains are taxable at 10%+sc+cess, effective 11.22% for direct investment and equity funds, but in the case of equity funds, the short term capital gain is subject to TDS at 33.6%, even though the applicable tax is much lower at 11.22%
Why mutual funds?
a. Range of products - from Liquid fund, to FMP, MIP and equity and FMP, mutual funds have them all. They can choose the product they are most comfortable with
b. Tax exempt income - Mutual fund dividends are fully exempt from tax. No TDS
c. Benefit of Indexation - They can choose a growth option in a debt fund, so that their long term capital gains can be indexed. The actual long term capital gain is thus drastically reduced
d. Procedural Ease - NRI's worry the most about the procedures for PAN and returns, and the hassle of getting the income tax refund. They will love a mutual fund product that gives them the return, which is tax exempt
e. Facility to re-invest dividend - In a mutual fund product, they can choose a dividend re-investment option that enables them to deal with payouts easily, without having to worry about small amounts getting credited into bank accounts
Which mutual fund products would appeal to the NRI's who are currently investing in fixed deposits?
a. Since the NRI's are comfortable with fixed income products, the FMP would appeal to them. The points to note are as under:
- It is important to check if there is a rollover option, so the investor knows
- Every FMP does not have both growth and dividend options. If only one option is available, tax implication is to be explained. If it is long-term capital gain (growth option, FMP>1yr), 10% LTCG tax (effective 11.22%) will apply as TDS, after indexation benefit. If it is a short term capital gain, 33.6% tax and TDS will apply. If it is a dividend option, the DDT will apply (13.07% effective)
b. If a NRI chooses to invest in debt mutual funds, a growth option is better than dividend option if the holding period is over 1 year. Only 10% LTCG (effective 11.22%) will apply. A dividend distribution will be subject to 13.07% effective DDT. If the holding period is less than 1 year, dividend option is better than growth option, because STCG is taxed at higher rates than the DDT
c. If the NRI chooses equity funds, the benefit is highest for long term holding. The dividends are tax exempt. So are LTCG. No TDS on long term capital gain
d. The short term holding in equity funds, is most unattractive. Though STCG is taxable at 11.22% effective, applicable TDS is 33.6%. If the NRI chooses a dividend reinvestment option, he can effectively earn tax-free returns from the equity investment
e. If the NRI likes some investment in debt and some in equity, the Child Care (Gift) Plan and the Balance fund are tax-advantaged options. They are equity-oriented funds, therefore subject to same tax treatment as equity funds in (c) above. But they have about 40% in debt instruments, if that gives the investors the comfort
How can NRI's protect their investment from currency fluctuations?
It is possible to buy a forward cover against the mutual fund investments, from a bank. A lien will be marked on the investments, and a cover for exchange risk can be purchased.
Can the money be repatriated?
As long as the investment is from a NRE account, and the banker certificate is attached to the application, the funds are fully repatriable. Only investments from NRO accounts are non-repatriable.
| Summary Table of Tax Implications of NRI Investment in Mutual Funds | |||
|---|---|---|---|
| Equity Funds | Debt Funds | TDS | |
| Short Term Capital Gains | 15% | As per slab | Equity - 15% Debt - 30% |
| Long Term Capital Gains | NIL | 10% (20% with indexation) |
Equity - Nil Debt - 20% with indexation |
| Dividends | Tax free | Dividends are tax free. Subject to ddt @ 12.5% + 10% SC + 3% Cess = 14.1625 | No TDS for equity or debt fund |
Surcharge for Resident Indians, Domestic companies and NRIs:
For Individuals, HUF, BOI and AOP, 10% surhcarge on tax payable if income exceeds Rs. 10 lakhs
For others including corporate bodies, 10% surcharge on tax payable
Education Cess
Education Cess is levied at the rate of 3% calculated on tax payable plus surcharge
A higher TDS is done on equity funds, despite the actual tax rate being low, due to the relevant tax law on TDS not having altered, even in this budget (2005-06). NRI's have to claim a refund on this TDS when they file their tax return.
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