Intermediate

Amended as on Apr 1, 2023: Please note that as per amendments in Finance Bill 2023, from April 1, 2023, profits made on investments in debt mutual funds are now taxed as short-term capital gains if these funds invest <=35% in equities. This means, debt mutual funds are now taxed as per the income tax rates as per an individual’s income.

Also note that with effect from Apr 1, 2020, Dividend Distribution Tax (DDT) was abolished, and mutual fund dividends were made taxable in the hands of investors. Dividend income is now considered as ‘income from other sources’ and investors need to pay tax on it as per their individual tax slabs.

This article is currently in the process of getting updated, as it was originally written at a time when tax rules were different. Please treat this note as the latest updated tax information in the meanwhile.

India is one of the fastest growing countries in the world. While you may reside abroad, as an Indian by birth, you naturally have roots firmly planted in India. You might also want to benefit from your country’s growth. The most convenient way to cash in on India’s growth is through its capital markets. The valuations of securities in Indian capital markets will reflect the country’s growth. In other words, market prices of securities will increase based on the rate of growth. By investing in these securities, you will see your investments concurrently grow.

While you can invest in nearly every kind of security available in the country, the problem is selecting and monitoring the securities in which you invest; this requires time and skills. A better option is to invest in India through mutual funds. All your investment needs – asset allocation, diversification, investing, monitoring investments – are taken care of by the mutual fund.

Before we discuss the investment options, let’s take a step back to check whether you are a non-resident Indian (NRI); an NRI is an Indian citizen or a person of Indian origin who resides abroad. NRIs must follow specific rules when investing in India.

Repatriation:

As an NRI, you can invest on either a repatriation basis or a non-repatriation basis.

Repatriation implies that you can transfer your investment capital, dividends and returns out of India. Non-repatriation implies the opposite (i.e. your investment capital, dividends and returns cannot be transferred outside India).

You can have three kinds of bank accounts in India. You can open all these three accounts with any bank in India and the accounts can be used to make investments in India.

Non-Resident External Rupee account (NRE account): Funds from an NRE account can be repatriated abroad.

Fully Convertible Non-Resident account (FCNR account): The FCNR account involves a fixed deposit in a foreign currency. Funds from this account can be repatriated abroad. However, this account cannot be used for investing in a foreign currency.

Non-Residential Ordinary account (NRO account): Funds from an NRO account cannot be repatriated abroad.

Note: You can repatriate the income and redemption amounts from your mutual fund investment only if you continue being an NRI at the time of repatriation. Also note that you cannot invest in foreign currency; in other words, your investments in Indian mutual funds must be made in Indian rupees.

Permissions:

Some countries, such as the United States and Canada, have levied restrictions on their residents investing abroad. Luckily, some Indian mutual funds have obtained permission for United States (US) and Canadian residents to invest in their funds. You must find out whether the fund of your choice has obtained such permission.

How to invest:

Investing in mutual funds is easy and convenient. You can invest offline or online. In the case of offline investing, you fill in a common application form on which you state the name of the scheme in which you want to invest. Along with the form, you need to submit a cheque or bank draft for the investment amount; this should be made in the name of the fund in which you are investing. You can send this directly to the mutual fund company or its registrar or have your financial advisor/mutual fund distributor submit it on your behalf.

To invest online, you fill in the form online, which is available on the mutual fund company’s website, and make your payment electronically.

In both cases, offline and online investing, you must have completed your Know Your Customer (KYC) and Foreign Account Tax Compliance Act (FATCA) requirements.

KYC:

When you invest in a mutual fund or any other financial instrument, the manager and custodian of your investment needs to have basic information about your identity. Central Know Your Customer (CKYC) is a process through which authorised institutions obtain and maintain investors’ identity information.

To fulfil your KYC requirements, you must submit the following documents along with your CKYC application:

Proof of identity: You can submit your photo PAN card or driving license /passport copy / voter ID /bank photo pass book.

Proof of address: You can submit your latest landline/mobile telephone bill, latest electricity bill, passport copy, latest bank passbook/bank account statement, latest dematerialized (electronic, or demat) account statement, voter ID, driving licence, ration card, rent agreement, or passport-size photograph.

For NRIs, a passport and proof of an overseas address are mandatory documents for KYC compliance.

You will submit your documents to a KYC registration agency (KRA) such as CAMS, Karvy etc. In-person verification/document attestation can be accomplished by visiting an AMC branch. For NRIs, this can also be accomplished through distributors or authorised officials of overseas branches of scheduled commercial banks registered in India, a notary public, a court magistrate, a judge, or the Indian Embassy/ Consulate General in the country in which the client resides.

You must go through the KYC process only once; that is, if you plan to invest in a number of schemes across different mutual funds, you don’t need to complete the KYC process for every investment.

KYC was initiated by the government to prevent money laundering.

FATCA:

The FATCA law was initiated by the US and requires mutual funds to report financial transactions of US persons to the relevant tax authorities. FATCA applies to you if you are a tax resident of the US.

To comply with FATCA, you must provide information which includes country of tax residence, tax identification number from such country, country of birth and country of citizenship, among other details.

FATCA was initiated to prevent US persons from avoiding US taxation on their income and assets.

Direct or regular plan:

You will also need to decide whether you want to invest in the fund’s direct plan or regular plan.

You can invest in a scheme’s direct plan if you are investing by yourself, i.e. without a mutual funds distributor being involved. Since you don’t pay any commissions here, the expense ratio in this plan is generally lower. Note that you could also take expert financial advice from a Registered Investment Advisor (RIA) while still choosing to invest in the direct plan. In such a case, you may need to pay the RIA a fee, directly, for his advice.

If you invest through a mutual fund distributor, you will be investing in the scheme’s regular plan. The distributor will earn a commission in return for his advice, which will be charged to you indirectly, via a higher expense ratio in this plan. The commission will effectively be paid to the distributor by the mutual fund (even though it’ll be from your own investment amount itself). Therefore, your cost for the same investment will be higher in this case than in a direct plan, if you invest by yourself.

Income distribution and redemption

Income distributed by the mutual fund and your redemption proceeds when you exit your mutual fund investment will be made in Indian rupees.

Redemption proceeds are usually credited to the investor’s bank account. The amount is paid to the first unit holder and will be credited to the bank account listed in the application. All currency losses are borne by the investors; similarly, all currency gains are also theirs to take. Note: The repatriation must be done by an authorised dealer or bank; the mutual fund is not responsible for repatriation.

Taxation:

Tax on income distributed by Mutual Funds and capital gains is the same as that which applies to resident Indians. Here are the details:

In the case of equity oriented mutual funds:

• Income Distributed by mutual funds are taxed at a rate determined by your income tax slab.
• Short-term capital gains (when you redeem your investment within a year) are taxed at 15% plus applicable surcharge and cess.
• Long-term capital gains in excess of Rs 1 lac (when you redeem your investment after a year) are taxed at 10% plus applicable surcharge and cess.

In the case of non-equity-oriented funds:

• Income distributed by mutual funds is taxed at a rate determined by your income tax slab.
• If the non-equity-oriented fund is a specified mutual fund which has no more than 35% of its assets invested in domestic equity securities, and is acquired on or after 1 April 2023, then all capital gains on it will be deemed to be short term and thus taxed at a rate determined by your income tax slab. Specified mutual funds acquired prior to 1 April 2023 will have similar tax treatment as non equity oriented funds, other than specified mutual funds (refer sr. no. (iii) below).
• iii. However, if the non-equity-oriented fund has between 35% and 65% of its assets invested in domestic listed equity, then short-term capital gains on it (i.e. when the holding period is less than 3 years) will be taxed as per your income tax slab. In case of long term capital gains, the rate also depends upon whether the units are listed or unlisted. The long-term capital gains will be taxed at a rate of 20% (plus applicable surcharge & cess) with indexation benefits if the units are listed. In case such units are unlisted then long-term capital gains will be taxed at a rate of 10% (plus applicable surcharge & cess) without indexation benefits.

Note: The tax structure given above is as per current Income Tax laws and may change in the future.