Non-Resident Indians (NRIs) investing in Indian mutual funds might legally avoid paying capital gains tax if certain Double Taxation Avoidance Agreement (DTAA) conditions are met. Let’s break down the important points you should know:
DTAA and the Residual Clause: How It Works
When India has a DTAA with another country and capital gains on mutual funds fall under the residual clause, taxation rights shift to the country of residence. If the NRI’s country of residence does not levy capital gains tax on mutual funds, the individual could potentially pay zero tax in India on those gains.
Real-World Example:
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Investor: Mr. A, an NRI living in the UAE.
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Investment: ₹50,000 monthly in Indian mutual funds.
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Investment Duration: 20 years.
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Assumed Annual Return: 12%.
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Outcome After 20 Years:
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Total corpus: ₹4.59 crore
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Initial invested capital: ₹1.2 crore
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Capital gains: ₹3.39 crore
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If Mr. A becomes a tax resident of the UAE after 20 years and fulfills the necessary DTAA requirements, his capital gains tax liability in India could be zero.
Why This is Possible:
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The India-UAE DTAA includes a residual clause, meaning taxation rights on mutual fund capital gains lie with the UAE.
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The UAE does not impose a capital gains tax on mutual fund investments.
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Important Caveat: If it’s proven that Mr. A moved primarily to avoid taxes, authorities could deny the tax exemption under anti-abuse rules.
Key Conditions NRIs Must Satisfy:
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Adherence to DTAA Provisions: Follow the tax rules of both India and the resident country.
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Tax Residency Certificate (TRC): Obtain a TRC from the UAE and submit it to the Indian Income Tax Department.
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Form 10F: Submit if the TRC lacks critical details like nationality, address, status, etc.
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Investment Sources: Investments can originate from resident, NRE (Non-Resident External), or NRO (Non-Resident Ordinary) accounts.
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Principal Purpose Test (PPT) Compliance: Prove that your primary objective of relocation was not tax avoidance. Documentation may include:
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Tax Identification Number (TIN)
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Period of residency
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Full residential address
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Nationality
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Individual or corporate status
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Countries Favorable to NRIs Due to Residual Clause and No Capital Gains Tax:
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Singapore
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United Arab Emirates (UAE)
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Mauritius
Countries Where Capital Gains on Mutual Funds Are Taxed in India:
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United Kingdom (UK)
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United States (US)
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Canada
Final Thoughts:
India has signed DTAAs with over 90 countries, and each treaty has unique provisions. NRIs must carefully examine the DTAA of their country of residence and ensure compliance with all documentation and residency requirements to benefit from zero capital gains tax on mutual funds.
Consult a tax advisor familiar with NRI tax planning and international taxation to make the most of these opportunities without falling foul of anti-abuse provisions.
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