For Non-Resident Indians (NRIs) investing in Indian mutual funds, a recent development based on Double Taxation Avoidance Agreements (DTAAs) offers a potential tax advantage. The Income Tax Appellate Tribunal (ITAT) in Mumbai has ruled that capital gains arising from the sale of mutual fund units by NRIs are not subject to taxation in India. Instead, these gains are considered only taxable in the NRIs’ country of residence. This benefit stems from a special provision under the India DTAA with certain countries.
The Legal Basis: DTAAs and the Residual Clause
India has signed DTAAs with around 90 countries to prevent investors from having to pay double taxes on incomes arising in one country to a tax resident of another. Under the DTAA, NRIs can potentially claim tax credits in India on earnings from mutual fund units, provided an agreement exists between India and their country of residence. With DTAAs in place, it is possible that the realized capital gains on mutual fund investments would not be taxed in India.
The key provision enabling this exemption is the “residual clause” found under the ‘capital gains’ article (often Article 13) in certain DTAAs. This clause typically states that gains from “the alienation of any property other than that referred… shall be taxable only in the contracting state of which the alienator is a resident”. This means that gains from assets not specifically mentioned elsewhere in the capital gains article (like immovable property or shares) are taxed only in the NRI’s country of residence.
Mutual Funds vs. Shares: A Crucial Distinction
A critical element in this tax exemption is the distinction between mutual fund units and shares. The ITAT’s stance is that mutual funds in India are created as trusts and not companies under SEBI regulations. As the term “share” is often not defined in the DTAA, and mutual fund units are not treated as shares under the Companies Act, they cannot be taxed as such. This treatment allows mutual fund units to fall under the residual clause.
The Landmark ITAT Ruling
The recent Mumbai ITAT ruling, based on the India-Singapore DTAA, highlighted this distinction. In the case of Ms. Anushka Sanjay Shah, a Singapore-based NRI, her claim for exemption on ₹1.35 crore in short-term capital gains from Indian mutual funds was initially rejected by the Assessing Officer, who treated mutual fund units as equivalent to shares. However, the ITAT ruled in favor of the taxpayer, asserting that mutual fund units are issued by trusts, not companies, and thus fall under the residual clause, making the gains not taxable in India.
This judgment makes capital gains from mutual fund investment tax-exempt for NRIs in countries like UAE and Singapore, which do not impose capital gains tax. It reinforces the distinction between mutual fund units and equity shares for tax treatment.
Countries Where This May Apply
The benefit of capital gains from the sale of mutual fund units not being taxable in India applies to tax treaties with other countries that have similar provisions, such as UAE, Oman, Saudi Arabia, Qatar, Singapore, etc.. Countries that are explicitly mentioned in the sources as potentially meeting the conditions (having a residual clause and not taxing capital gains) include the United Arab Emirates, Singapore, and Mauritius. Other countries with relevant DTAAs mentioned include Luxembourg, Switzerland, Portugal, Spain, Netherlands, Hong Kong, Australia, France, and Germany. India has DTAAs with more than 90 countries, so additional countries may qualify.
It is important to note that under India’s DTAAs with countries like the United Kingdom, the United States, and Canada, any capital gains from Indian assets are generally taxed as per Indian tax laws. Also, due to stringent compliance procedures under FATCA, not many mutual fund houses currently allow NRIs from the USA and Canada to invest in their schemes.
Conditions to Qualify for the Exemption
To legitimately claim this tax exemption, NRIs must generally meet several conditions:
- NRI Status: You must be an NRI as per Indian Income Tax laws, meaning your stay in India should not be for more than 182 days during the relevant financial year. Non-Resident status as per KYC records and submission of a FATCA declaration should suffice as proof of Non-Resident status.
- Tax Residency Abroad: You need to be a tax resident of the other country as per Article 4 of the relevant DTAA. To become a tax resident abroad, you must typically have stayed in that country for at least 183 days in a financial year. Even if you are a resident of both countries as per domestic law, you might qualify as an ultimate tax resident of the other country based on DTAA tie-breaker rules.
- DTAA Provisions: The DTAA between India and your country of residence must include a residual clause under ‘capital gains’ that allocates taxing rights to the country of residence.
- Taxation in Residence Country: To benefit from zero tax, you must be a tax resident of a country that doesn’t tax capital gains.
Documentation Required
To avail of DTAA benefits, specific documentation is necessary:
- Tax Residency Certificate (TRC): This is a crucial official document issued by the tax authorities of your country of residence certifying your tax residency for a specific financial year. The TRC mentions your residential status and other details. It is essential for claiming tax relief under DTAAs. However, obtaining a TRC can be an expensive proposition and there are challenges that differ by country. In the UAE, the TRC might be issued only for the previous year. You also need to be careful about getting the correct type of TRC – one for domestic law vs. one for DTAA benefit.
- Form 10F: If your TRC does not contain all required details like TIN, status, nationality, period of residency, and foreign address, you must additionally furnish Form 10F electronically to the Indian Income Tax Department. Form 10F provides details that qualify for tax benefits under DTAA rules.
- Other Details: You may also need to submit documents like a Residency Card issued by the country of residence or a FATCA declaration. For obtaining something like an immigration report/TRC in Dubai, you might need to show proof of income like folio statements or provide supporting documents if retired or sponsored.
- Updating Details: Inform your fund house of your NRI status and ensure your mutual fund investments are linked to an NRE or NRO account.
- Submission Timeline: All required documentation must generally be completed and submitted before redeeming your mutual fund units to help ensure TDS exemption.
TDS and Refund Process
Mutual funds typically deduct Tax Deduction at Source (TDS) on capital gains for NRIs at applicable rates at the time of redemption. For equity funds, the STCG TDS rate for NRIs is 20%, and for LTCG (over ₹1.25 lakh), it’s 12.5%. For debt funds, the TDS rate is 30%. If a PAN is not furnished, TDS is deducted at a higher rate.
Despite TDS deduction, if the capital gains are exempt under the DTAA, you can claim a refund of the excess tax deducted by filing your income tax return in India. It is believed that some AMCs might not deduct TDS if the TRC and Form 10F are filed by the investor. The liability for deducting TDS rests with the mutual fund.
Challenges, Risks, and Future Considerations
While the ITAT ruling and DTAA provisions offer significant potential tax savings, there are challenges and risks:
- Practical Difficulties: Obtaining a TRC can be expensive and time-consuming. The process and requirements differ from country to country.
- Tax Authority Scrutiny: Claiming the benefit might lead to scrutiny by tax authorities. The claim might be converted to demands by the ITO. Fighting against such demands requires an appeal, which can involve depositing a certain amount of tax and incurring high fees from appellants.
- Anti-Abuse Rules: Tax authorities may invoke rules like the General Anti Avoidance Rules (GAAR) if the tax benefit exceeds ₹3 crore annually, or the Principal Purpose Test (PPT) introduced under the Multilateral Convention (MLI). These rules allow authorities to question the legitimacy of a move abroad if one of the main reasons appears to be solely for tax benefits. Intent matters, and temporary relocation without real substance could invite scrutiny. The “Substance Over Form” doctrine suggests authorities may look at your real connection to a country rather than just paperwork.
- Changing Laws and Treaties: DTAAs can be amended, and tax interpretations may evolve. There are concerns that this provision could be abused by “seasonal non-residents”. Experts believe that since this issue has gained attention, the government may try to amend treaties or the Income Tax Act to include mutual fund units, potentially plugging this loophole.
Tax planning is legitimate, but relocating solely for tax savings without a genuine long-term plan could backfire. It is vital to consult a qualified tax advisor to navigate these complexities and remain compliant. The type of account used for the initial investment (resident, NRO, NRE) generally doesn’t affect DTAA eligibility, but repatriation rules differ (NRE fully repatriable, NRO/resident investments limited to $1 million per year).
TABLE : DTAA Treatment of Capital Gains on Indian Mutual‑Fund Units for Selected Countries –
Source : Quantum mutual fund.



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