1. Introduction
In recent years, a growing number of wealthy Non-Resident Indians (NRIs) have utilized the Double Taxation Avoidance Agreements (DTAA) between India and select foreign nations to legally eliminate capital gains tax on mutual fund investments in India.
The strategy revolves around residing in countries where capital gains on mutual funds are either not taxed or the taxation rights lie with the country of residence, as per the provisions of the DTAA.
Countries such as the United Arab Emirates (UAE), Singapore, Mauritius, Malaysia, Oman, Qatar, Saudi Arabia, Kuwait, and Bahrain are among those that offer this unique tax advantage.
This document provides a legal overview, interpretation of the relevant provisions, a strategic approach for implementation, and a detailed checklist and declaration template to guide the process of claiming this tax benefit efficiently.
2. Relevant Legal Framework
A. Income Tax Act, 1961 – Section 5 and Section 90(2)
Under the Income Tax Act, 1961, the taxability of income for an individual is primarily determined by their residential status:
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Section 5: The income of a person is taxed in India depending on their residential status. Non-Residents are taxed only on income sourced from India or income received in India.
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Section 90(2): This provision allows an individual to opt for the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and their country of residence, if the provisions of the DTAA are more beneficial than the domestic tax laws.
B. DTAA – Article on Capital Gains (Typically Article 13)
Most DTAAs between India and foreign countries contain specific provisions regarding the taxation of capital gains arising from the sale of property other than immovable property (which includes mutual fund units).
Under such agreements, capital gains are typically taxable only in the country of residence of the taxpayer, with the specific provision varying across agreements.
For example, the India–UAE DTAA, Article 13(4) provides:
"Gains derived by a resident of a Contracting State from the alienation of any property other than immovable property ... shall be taxable only in that State."
Thus, when the country of residence does not levy capital gains tax (e.g., UAE), and the DTAA restricts India’s taxing rights, these gains are not subject to tax in India.
C. Section 90(4) and Section 90(5) – Documentation Requirement
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Section 90(4) mandates that individuals claiming DTAA benefits must obtain a Tax Residency Certificate (TRC) from the foreign tax authorities to substantiate their claim.
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Section 90(5) requires the submission of Form 10F, along with other necessary documentation, for the successful claim of benefits under the DTAA.
3. Interpretation and Analytical Explanation
A. Legal Interpretation
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Non-Resident Status and Capital Gains Tax:
According to Section 6 of the Income Tax Act, 1961, an individual must be outside India for more than 182 days in the relevant financial year to qualify as a Non-Resident Indian (NRI). For NRIs, only income earned in India or received in India is taxable under Indian laws. -
DTAA Exemption on Capital Gains:
As per Section 90(2), NRIs can avail themselves of the provisions of the DTAA, which often provides that capital gains from the sale of mutual fund units are taxable only in the country of residence.
If the country of residence does not impose capital gains tax (such as in the UAE, Singapore, etc.), these gains are exempt from tax in India as well. -
Documentation Requirements:
The legal validity of this exemption relies on proper documentation:-
The Tax Residency Certificate (TRC) confirms the individual's status as a tax resident in the foreign country.
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Form 10F substantiates the taxpayer's claim and provides details of the foreign tax identification number, address, and residency status.
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Anti-Avoidance Measures:
It is important to ensure that the NRI's stay in the foreign country is genuine and not artificially structured to claim tax exemptions. The General Anti-Avoidance Rules (GAAR) may apply if the tax residency is deemed to be a sham or temporary.
4. Strategic Approach and Planning
Here’s a clear, structured approach for NRIs planning to benefit from the capital gains tax exemption under DTAA provisions:
Step-by-Step Plan for Claiming DTAA Benefit:
| Step | Action |
|---|---|
| 1 | Obtain long-term residence visa (e.g., UAE Golden Visa) and establish residence in a DTAA country. |
| 2 | Stay abroad for more than 182 days in the relevant financial year (under Section 6 of the Income Tax Act). |
| 3 | Establish physical residence — rent a property, open bank accounts, and accumulate relevant documentation (e.g., utility bills, residence permit). |
| 4 | Apply for Tax Residency Certificate (TRC) from the foreign country’s tax authorities, covering the entire financial year of the capital gains realization. |
| 5 | Submit Form 10F through the Indian Income Tax Portal, declaring the foreign tax identification number and confirming NRI status. |
| 6 | Sell/redeem mutual funds after obtaining TRC and Form 10F, ensuring compliance with NRI status at the time of the transaction. |
| 7 | File Income Tax Return (ITR) in India, disclosing the capital gains and claiming DTAA exemption under Section 90(2) and the relevant DTAA provisions. |
| 8 | Attach supporting documents: TRC, Form 10F, proof of foreign residency, sale/redemption statements, and a declaration confirming genuine tax residency. |
5. Compliance Checklist for DTAA Capital Gains Exemption
Ensure all of the following for successful execution:
| Action Item | Details |
|---|---|
| Residential Status | Stay abroad for >182 days during the financial year; maintain proof of physical residence (e.g., tenancy agreements, utility bills). |
| Tax Residency Certificate (TRC) | Obtain TRC from the foreign tax authority. |
| Form 10F | Upload Form 10F on the Income Tax Portal, detailing foreign residency status and tax identification. |
| Mutual Fund Transactions | Record all capital gains transactions — including date of investment, date of redemption, and gain amount. |
| Supporting Documents | Keep passport, visa/residence card, foreign bank account statements, TRC, Form 10F, and mutual fund sale contracts. |
| ITR Filing | Correctly report mutual fund capital gains and claim exemption under DTAA provisions in ITR. Attach TRC, Form 10F, and other necessary documents. |
| Audit Trail | Retain a copy of all documentation for at least 8 years for potential future verification by Indian tax authorities. |
6. Sample Declaration Format
This declaration must accompany the ITR filing to assert the claim of DTAA exemption:
[Declaration Format for DTAA Capital Gains Exemption]
Date: [Insert Date]
To
The Assessing Officer,
Income Tax Department,
[Insert Jurisdiction]
Subject: Declaration for Claiming Exemption on Capital Gains under India–[Country] DTAA for FY [Year]
I, [Full Name], PAN: [Insert PAN], presently residing at [Foreign Address], do hereby declare:
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I am a Non-Resident under Section 6 of the Income-tax Act, 1961 for FY [Insert Year].
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I am a tax resident of [Country] and hold a valid Tax Residency Certificate (TRC).
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The capital gains earned from the sale/redemption of Indian mutual funds during the year are disclosed in my Income Tax Return (ITR).
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As per Article 13 of the India–[Country] DTAA, such capital gains are taxable only in the country of residence.
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The country of my residence ([Country]) does not levy capital gains tax.
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I have attached all necessary documentation, including the TRC, Form 10F, and proof of residence.
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I affirm that this tax residency is not a sham or temporary, but is in line with the regulations of the foreign country.
Verification:
I solemnly declare that the above is true and correct to the best of my knowledge and belief.
Signature: ___________
Name: [Full Name]
Passport No.: [Passport Number]
PAN No.: [PAN Number]
7. Key Benefits of This Strategy
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Zero Indian tax on mutual fund capital gains for NRI residents of DTAA countries.
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No capital gains tax in countries like UAE, Singapore, etc., if they don't levy it.
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Legally compliant strategy with proper documentation.
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Freedom of reinvestment or repatriation of funds without tax concerns.
Conclusion
Leveraging the DTAA capital gains exemption requires careful planning, substantial documentation, and an understanding of both Indian tax laws and foreign residency laws. By following the outlined steps and ensuring proper compliance with TRC and Form 10F, NRIs can efficiently minimize their tax liabilities on mutual fund investments.