Q: Can NR/s invest in Mutual Funds (MFs)? Do they require any special permission fom the RBl?

A: NRIs are eligible to invest in MFs on a repatriable as well as a non-repatriable basis. RBI has granted general permission in this regard and as such no special permission is required each time an NRI desires to invest.  

Q: Are there any specific procedures to be followed for making the investment on a repatriable basis?  

A: The investment should be made by the non-resident investors out of Funds remitted from abroad in free foreign exchange through normal banking channels or out of balances held in their NRE/FCNR accounts maintained with Authorised Dealers (A.D.) in India. Payment may be made by means of Indian Rupee Drafts purchased abroad or by a cheque drawn on NRE/FCNR accounts payable at Mumbai. Payments can also be made from funds held in NRE/FCNR accounts maintained with banks authorized to deal in foreign exchange in India.

The above may be sent together with the complete application form directly by registered post to the registrar or the office of the AMC.

Q: What are the taxes applicable for income from MFs?

 A: There are essentially two kinds of incomes that NRI investors would earn from MFs - Dividends and Capital gains (upon redemption of units). Capital gains are further segregated into short term gains and long-term gains. Taxation treatment differs as per the kind of income.

Dividends from MFs are completely tax-free in the hands of the investor as per Sec.10(35) of the Income Tax Act. However there is a distribution tax @14.025% (including surcharge €? cess) payable by the MF directly to the exchequer. So in effect, the investor would stand to receive that much lesser dividend. Equity based schemes are exempted from this tax. As far as capital redemption is concerned, tax treatment differs for equity oriented schemes vis a vis other schemes such as income schemes etc.  

Tax treatment for non-equity oriented schemes

If the units of any MF are held for more than 12 months, the same would qualify as long-term capital assets. Else, these would be termed as short term capital assets. Upon sale, any short-term capital asset is taxed at the normal rates applicable to the investor. These are:

Income up to Rs. 1, 00,000 is not taxable. Income from Rs. 1, 00,000 to Rs. 1, 50,000 is taxed @10%. Income between Rs. 1, 50,000 and Rs. 2, 50,000 is taxed @20% and above that level, it is @30%. There is a surcharge of 10% of the income tax for income over Rs. 10, 00,000. Surcharge is payable by both Residents and NRIs. In the case of sale of MF units which are long-term capital assets capital gains tax is payable @10% without indexation or @20% with indexation, whichever is lower.

Such long-term gains of NRIs are not eligible for the Rs. 1, 00,000 basic exemption threshold, income below which tax is not payable. Therefore, for any amount of long-term capital gains income, tax is payable and tax returns would need to be filed. However the Rs. 1,00,000 threshold is available for short-term capital gains and therefore short-term capital gains would not be taxable up to Rs. 1,00,000, of course, assuming that the NRI has no other income in India.

If the funds are invested in growth option of MF schemes, the growth is not taxable as long as there are no withdrawals (sale or repurchase).

Tax treatment for equity oriented schemes

Securities Transaction Tax (STT) of 0.20% is payable upon redemption in case of equity oriented schemes. Consequently, any long-term capital gains (LTCG) are exempt and the tax rate on short-term gains (STCG) would be @10%.

Q: What about the special threshold rates of Rs. 1 , 35 000 for ladies and Rs. 7, 85 000 for senior citizens?  

A: For reasons best known to the authorities, these special limits for ladies and senior citizens are applicable only to Residents and not to NRIs.

Q : What are the provisions regarding Tax Deduction at Source (TDS) a.ka, withholding tax?  

A: Since the dividends from units are tax-free in the hands of the investor there is no question of TDS thereon. However capital gains are subject to TDS.

The TDS on long-term capital gain is @20% and on short-term gains is @30%. If either income is more than Rs. 10, 00,000, a surcharge of 10% would be levied on such rates. The education cess of 2% is also applicable. Consequently, for incomes above Rs. 10, 00,000, the TDS rates would be 22.44% and 33.66% respectively.

For equity-oriented schemes, since long-term capital gains are tax free, there is no TDS applicable.

However, though on such schemes, STCG is taxed @10%, the TDS rate as per the law has remained unchanged at 30%. This gives rise to the anomaly that the final tax liability is lower than the withholding tax rate. Reportedly, some MFs have sought a legal opinion and are in the process of cutting tax at the lower rate of 10%.

Q: In which case wouldn't Bank deposits like FCNR & NRE 6° NRO where the interest is fully tax-free be better investments than MFs?  

A : It is only interest from NRE and FCNR accounts that is tax-free, interest from NRO account is fully taxable. Also, apart from tax, one has also to look from the absolute return point of view. The average interest on a Dollar based FCNR deposit is around 4.5% p.a. and that on an NRE deposit is around 5.6% p.a. Also the money is locked in for the duration of the deposit. On the other hand, the average returns from an average equity mutual fund scheme are far higher than these rates. The difference gets further magnified if one compares the returns of a well performing MF scheme. Secondly, most liquid and floating rate plans of MI's yield comparable returns without the associated lock-in.

Q: Are the Special Provisions relating to NR/5 u/ 1 15C to 1751 applicable?

A: Under these provisions, the benefit is in the form of investment income being taxed @20% and long-term capital gains @10%. In the case of MFs, dividends are tax-free in any case and long term gains are taxed @10% or NIL as the case may be. Therefore, the non-applicability of the Special Provisions is of no consequence to the NRI.  

Q: What is the tax saving methods that an NRI can use to sdve tax on income fom MFs?  

A: There are several ways to save tax on long-term gains that an NRI can employ.

a.Investment u/s 54EC

      Sec. 54EC offers tax exemption if the long-term gains are invested in Bonds of NABARD, NHAI, REC, NHB and SIDBI within a period of six months from the date of transfer These bonds have a lock-in of three years. The interest payable on the bonds (in the range of 5% - 5.25%) is fully taxable. However, there is no TDS. If only a part of the capital gain is invested, exemption would be proportional.  

b. Investment u/s 54ED 

Sec. 54ED offers tax exemption if the long-term gains are invested in acquiring equity shares forming part of an eligible issue of capital (IPO) within a period of six months from the date of transfer. If only a part of the capital gain is invested, exemption would be proportional. If the newly acquired shares are sold or transferred within one year the capital gains from the original asset will be charged to tax in the year of the sale or transfer.

 c. Investment u/s 54F

 Exemption u/s 54F is available if the investor purchases within one year before or two years afer the date of transfer or constructs within three years afer such date a residential house. If the cost of the house is not less than the net consideration, the entire capital gain is exempt from tax. Else, the exemption would be proportional. The investor should not own more than one residential house at the time of transfer nor should he purchase another residential house for 2 years from the date of transfer of the Units. The new residential house should not be sold for 3 years. This covers the broad sweep of the tax and procedural provisions of the law applicable to NRI investors as of now. However one can never say when what will change. However when it does, it will surely be reported on this site. Watch this space for any updates.