Paying a hefty tax bill on your mutual fund gains? What if shifting residency to a tax-friendly nation could make it disappear? The Income Tax Appellate Tribunal (ITAT) recently offered relief to a Singapore resident investor, upholding his claim that the capital gains he fetched from the sale of mutual fund units in India are not taxable in India. This ruling is significant for non-resident Indians (NRIs) investing in domestic mutual funds. It also sparked discussions on avoiding higher tax outgo by shifting domicile to specific tax-friendly countries. But is this path worth exploring?
What the law says
India offers tax exemption on capital gains from the sale of mutual fund units to individuals residing in countries that have a Double Taxation Avoidance Agreement (DTAA) with India. In specific tax treaties, exemption from capital gains in the host country is provided under the “residual” clause. “This clause gives taxability rights squarely to the country of residence of the seller,” points out Ashish Karundia, Founder, Ashish Karundia & Co. However, this applies only to assets other than immovable property and shares.
In the matter heard by the ITAT, the Singapore tax resident had declared capital gains of Rs 88.75 lakh from debt mutual funds and Rs.46.91 lakh from equity mutual funds in 2021-22. In her I-T return, she claimed exemption for these capital gains under the residual clause of Article 13 of the tax treaty. The I-T officer had rejected the claim and taxed the capital gains, by contending that the mutual fund units derived substantial value from Indian assets and, as a result, would be subject to tax in India. In her appeal to the tribunal, the appellant argued that the units of mutual funds do not qualify as ‘shares’ and thus fall outside the scope of taxable capital gains under the I-T Act read with the tax treaty provisions.
Citing earlier precedents, the tribunal held in her favour, noting that units of Indian mutual funds are issued by trusts and not companies, and therefore, cannot be equated with ‘shares’. As Singapore doesn’t levy capital gains tax, Shah paid zero tax on the gains. Kuldip Kumar, Partner, Mainstay Tax Advisors, observes, “Prior to the amendment of Singapore tax treaty in 2016, gains in shares of any Indian company sold by a Singapore resident could be taxed only in Singapore. Post the amendment, India can tax such gains, but the law interprets mutual funds are not shares and exempts them from such tax in India.”
This relief has caught many unaware. Many qualifying NRIs miss out on claiming exemptions and are taxed by mutual funds at source. For NRIs, TDS on MF gains gets deducted at the applicable rates regardless of the individual’s income tax slab. The tax rates for NRIs investing in mutual funds are the same as those for resident Indians. However, TDS is deducted at a higher rate if the individual does not furnish his/her PAN. NRIs can claim a refund of the excess tax deducted by filing their income tax returns in India, points out Kalpesh Ashar, Founder, Full Circle Financial Planners. If tax return is not filed, no tax refund will be processed.
However, the specific provision that allows tax exemption to NRIs existed earlier. The recent ruling has not changed the interpretation of existing law in any way. “It has merely brought clarity to a provision that many were not aware of,” insists Ashar. Rohit Shah, Founder, GYR Financial Planners, says, “The ruling makes it amply clear that this provision exists and can be leveraged by NRIs.” Of course, this tax benefit works only if the tax liability in the seller’s country of residence is zero.
Stringent criteria
NRIs must meet specific criteria to claim this tax exemption. First, they must qualify as tax residents of the other country. This benefit applies to tax treaties with countries such as the UAE, Singapore, Mauritius, the Netherlands, Spain, and Portugal. “The residual clause is only present in tax treaties with specific countries with whom India has a DTAA. So every DTAA country may not afford this provision,” Karundia points out. Countries like the USA, Canada, the UK, and Australia, among others, do not offer this relief, even though India has a DTAA with them.Further, tax residency depends on the number of days you have stayed in that country. For instance, in case of the UAE and Singapore, only an individual who has stayed in that country for 183 days or more in the respective calendar year can qualify as a ‘resident’ for DTAA purposes. Importantly, the individual must qualify as a resident of the other country at the time of the sale of investment, not necessarily at the time of the investment itself. “Taxability is determined on the basis of residency status at the time of redemption of units,” clarifies Karundia.
If you move abroad after making initial investment and become an NRI later, you must update the relevant KYC details and link your mutual fund holdings to an NRE (Non Resident External) or NRO (Non Resident Ordinary) account. NRIs should duly inform fund houses about their NRI status before date of redemption. “The investor must provide tax residency certificate and file a declaration in Form 10F,” points out Ashar. The tax residency certificate is issued by the taxpayer’s home country. It contains information such as the taxpayer’s name, foreign address, TIN (Tax Identification Number) and the taxpayer status. If the tax certificate does not contain these details, the individual must file Form 10F electronically. Form 10F is necessary to claim the benefits of India’s tax treaties with foreign countries. This allows the fund company to process the TDS exemption. However, experts point out that not all Indian mutual fund companies facilitate the processing of this tax exemption. “Only some AMCs are enabling this tax provision,” Shah says.
As an NRI, you can invest in mutual funds on a repatriable or non-repatriable basis. If you invest through your NRE account, all the investment proceeds are fully repatriable. However, if you wish to invest from your NRO account, then the proceeds are repatriable only up to $1 million cumulatively for all NRO accounts held in India per financial year (April–March). Also, if the investment in mutual funds was made when you were a resident of India (non-repatriation basis), you will not be able to repatriate the sale proceeds outside India, except up to $1 million per financial year.
Exploiting tax gap not simple
Experts say that many Indians shift their domicile to tax-friendly nations to take advantage of treaty provisions. Some individuals are known to work or stay in these countries for a specific number of days each year. Financial advisors maintain that genuine NRIs should make use of this benefit. Debt funds in India particularly are tax inefficient, with gains taxable at the applicable slab rate. However, this provision would allow eligible NRIs to enjoy capital gains in debt funds without incurring a tax liability. These can even replace the NRE Fixed Deposit Account for NRIs, which earn tax free interest on savings.
“NRI investors have a similar opportunity to invest in debt funds without paying any tax,” Shah points out. In complex situations, he insists on taking the professional opinion of a Chartered Accountant in writing before claiming such exemption.
If you are keen to shift domicile for saving tax outgo, be mindful of potential roadblocks. Availing TRC certificate itself may not be easy. UAE, for instance, has stopped issuing TRC on a forward basis. Its TRC is now valid only for the preceding year of stay. This prevents the investor from filing for TDS exemption before date of redemption. Besides, even if DTAA provisions allow it and the ITAT ruling makes its interpretation very clear, your tax exemption claim as NRI may get disputed, if it can be proved as tax avoidance. The General Anti Avoidance Rule (GAAR) may be invoked by the tax authorities under the Income Tax Act in certain cases. This is an anti-tax avoidance law created to prevent individuals or companies from using legal gaps to evade taxes.
“GAAR can be invoked against NRI tax exemptions if the provision is found to be abused in any way,” Karundia observes. GAAR provisions usually apply to tax benefits exceeding `3 crore in a financial year. If you show intent to evade taxes, such as moving in and out of the country for specific number of days, your claim may get challenged. NRIs must be able to prove that they have emigrated for valid reasons other than merely claiming tax concessions.
“Nowadays, tax authorities are keeping a very close eye on movements, along with regular exchange of information between countries,” cautions Kumar.
Financial planners warn against shifting domicile for tax purposes. “Taxation should never form the fulcrum of such an important life decision,” insists Shah. “You never know when the law or its interpretation can change. You must also weigh the impact of relocating on your health and family,” he adds. Ashar concurs, “Shifting domicile to a different country must be done only after a lot of thought, and for reasons bigger than tax savings.” Everybody’s financial profile is different, so don’t look at tax in isolation, he adds.
Moving abroad may save you taxes, but taxman is watching
How NRIs escape tax on MFs
- India has double taxation avoidance agreement (DTAA) with specific nations.
- If DTAA contains residual clause, taxability rights belong to the seller’s country of residence, except in case of shares and immovable property.
- Tax arising on sale of MF units in India is exempted as MFs do not qualify as shares.
- This is in seller’s favour if the tax liability in the country of residence is zero.
How to Claim DTAA Benefits
- Verify that you are a tax resident of a country that has a DTAA with India, containing the residual clause.
- Avail Tax Residency Certificate from the tax authority in your country of residence.
- Collect supporting documents (income statements, any relevant agreements or contracts)
- File a declaration in Form10F to enable the mutual fund company to process TDS exemption (before date of sale)
- When filing tax return in your country of residence, either claim exemption under the DTAA or claim credit for taxes paid in the source country.
But you may still come under tax scanner
- Your tax exemption claim as NRI may yet get disputed, if it can be proved as tax avoidance.
- The General Anti Avoidance Rule (GAAR) may be invoked by the tax authorities under the Income Tax Act in certain cases.
- NRIs must be able to prove that they have emigrated for valid reasons other than for claiming tax concessions.
