Leveraging Double Tax Avoidance Agreements (DTAA) to Minimize Capital Gain Taxes on Bonds and Mutual Funds for Germany/Singapore/UAE/Netherlands Non-Resident Indians
In the globalized world, Non-Resident Indians (NRIs) residing in various countries such as Singapore, Germany, UAE, Netherlands, and more, can strategically utilize the Double Tax Avoidance Agreement (DTAA) to mitigate capital gain taxes in India.
First and foremost, understanding how we ascertain the residential status of individuals is crucial. This will be determined based on the number of days of stay in India. According to section 6(1) of the Income Tax Act, 1961, an individual is resident in India for a particular previous year if they fulfill either of the following conditions:
1. They have been in India for 182 days or more during the relevant previous year. or
2. They have been in India for a total of 365 days or more in the four years immediately preceding the relevant previous year, with at least 60 days of presence in the relevant previous year.
If both the above conditions are not satisfied, the individual is a non-resident. While there are exceptions to these conditions for determining residential status, our primary focus here is on leveraging the benefits of the Double Taxation Avoidance Agreement (DTAA), so we’ll set aside these exceptions for now.
A non-resident Indian (NRI) is an individual originally from India who resides in a foreign country while retaining Indian citizenship. NRIs are termed as such due to their relocation abroad. A “Non-Resident” is someone who has not resided in India for a specified period. Put simply, an NRI can also be described as someone who spends more than 183 days in any foreign country.
The Double Tax Avoidance Agreement (DTAA) is an agreement that has been signed between India and other countries. According to the agreement, an individual earning an income in another country while being a resident of another country does not have to pay two (double) taxes on the same income.
Let’s dig into how NRIs can leverage DTAA to mitigate taxes on capital gains in India. Initially, three prerequisites must be met, outlined below:
- The individual must be classified as a Non-Resident.
- They must procure a tax residency certificate from the relevant foreign tax authorities.
- Filing Form 10F on the income tax portal is necessary to avail the DTAA benefits.
Under the DTAA between India and countries like Singapore, Germany, UAE, Netherlands, and others, a crucial provision lies in Article 13, which specifically addresses capital gains taxes.
Here are the extracted wordings from Article 13 (4) and (5) for reference:
- “Gains from the alienation of shares other than those mentioned in the above paragraph of this article in a company that is a resident of a Contracting State may be taxed in that State.”
- “Gains from the alienation of any property other than that referred to in the above paragraphs of this article shall be taxable only in the Contracting State of which the alienator is a resident.”
In essence, Article 13(4) of the DTAA of the aforementioned countries pertains to the taxation of gains from the sale of shares in India. On the other hand, Article 13(5) addresses how any transfer besides shares and immovable properties will not incur taxation in India.
Therefore, it can be concluded that transfers involving mutual funds and bonds in India by NRIs will not be subject to taxation in India, as per the provisions of Article 13(5) of the DTAA.
However, there’s a crucial caveat to consider. Tax treaties are designed to prevent double taxation between the source country and the resident country. When NRIs invest in bonds and mutual funds in India, it can lead to what’s known as double non-taxation, meaning no tax liability in either India or the above-mentioned countries. Such scenarios often invite legal scrutiny, although favourable rulings do exist.
One notable case is the ITAT ruling in the matter of Sri K.E. Faizal, adjudicated by the Cochin bench (ITA No. 423/ Coch/ 2018: A.Y 2012-23). In this case, it was determined that units of equity-oriented mutual funds do not fall under the category of “shares.” Consequently, the short-term capital gains derived from the transfer of such units should be exempt from taxation under Article 13(5) of the India-UAE Double Taxation Avoidance Agreement (DTAA). This ruling provides a lucrative opportunity for investors to optimize their tax obligations by strategically investing in equity-oriented mutual funds.
Conclusion: Harnessing DTAA provisions enables NRIs to navigate complex tax landscapes, particularly regarding capital gains on investments in India. With strategic planning and adherence to legal interpretations like the Sri K.E. Faizal case, NRIs can effectively mitigate tax burdens and optimize their investment returns, fostering financial growth and security.
