DTAA India-USA Capital Gains: Why MF Gains for US NRIs Get Taxed in India and Reported in US

For a US-resident NRI holding Indian mutual funds, the same capital gain is reportable to two tax authorities: taxed first in India under the Income-tax Act 1961, then disclosed afresh on the United States Form 1040. The architecture that decides who taxes what, and who must yield, is Article 13 of the India-USA Double Taxation Avoidance Agreement (DTAA) signed on 12 September 1991. Read with Article 24 (relief from double taxation) and the punitive Passive Foreign Investment Company (PFIC) rules in Internal Revenue Code Sections 1291 to 1298, the practical answer is rarely "exempt" and almost always "tax in India, then claim a credit in the US."

This guide walks through the FEMA and DTAA position, the Indian taxing rates effective from Budget 2024 (rolled forward into FY 2025-26), the US side under the PFIC regime, and the FEMA repatriation pipeline that closes the loop. Every rate cited is sourced to the Income-tax Act, the DTAA text, or US Treasury regulations.

FEMA / DTAA Position

The starting point is residency. A US NRI is a "resident" of the United States under Article 4 of the DTAA (typically by green card or by the substantial presence test under IRC Section 7701(b)) and a "non-resident" under Section 6 of the Income-tax Act 1961 because they are outside India for 183 days or more in a financial year. Mutual fund units held in India are "movable property situated in India," so the income arises in India under Section 9(1) of the Act.

Article 13 of the India-USA DTAA, accessible on incometaxindia.gov.in, splits taxing rights by asset class. Article 13(5), the residual paragraph, states that "gains from the alienation of any property other than that referred to in paragraphs 1 to 4 shall be taxable only in the State of which the alienator is a resident." However, Article 13(6) carves out an exception: each Contracting State may tax in accordance with the provisions of its domestic law. Net effect: India taxes first as the source State; the US then taxes as the residence State and grants a credit under Article 24.

This is a critical point. Anyone who tells a US NRI that mutual fund gains are "exempt under the DTAA" is wrong. The treaty merely caps certain rates (dividends at 15% portfolio, interest at 15%, fees for technical services at 15% under the "make available" test of Article 12) and ensures the US grants a foreign tax credit; it does not zero out Indian capital gains tax.

Under FEMA 1999 read with the FEMA (Deposit) Regulations 2016, US NRIs can buy Indian mutual funds only through Non-Resident External (NRE), Non-Resident Ordinary (NRO) or Foreign Currency Non-Resident (FCNR) routes; direct dollar inward remittance is allowed only via the NRE leg. Most US-domiciled investors are restricted by 35 of 44 fund houses because of US Securities and Exchange Commission registration requirements; ICICI Prudential, Aditya Birla Sun Life, UTI and a handful of others accept US NRIs subject to physical KYC under the FATCA declaration mandated by SEBI Circular CIR/MIRSD/2/2015 dated 26 August 2015.

Tax Treatment in India

The Finance (No. 2) Act 2024, applicable from 23 July 2024 and continuing for FY 2025-26, harmonised long-term capital gains across asset classes at 12.5% without indexation and short-term equity rates at 20%. Section 112A governs equity oriented schemes (those holding 65% or more in domestic equity), Section 111A governs equity STCG, and Section 50AA (inserted by Finance Act 2023, effective 1 April 2023) treats specified mutual funds (debt-oriented with less than 35% equity) as deemed short-term irrespective of holding period, taxable at slab.

For an NRI, withholding (TDS) is sharper than for residents. Section 196A applies a 20% TDS on dividend income from Indian mutual funds paid to non-residents, plus surcharge and 4% health and education cess. Section 196B applies 10% TDS on income from units of an offshore fund. On redemption gains, the AMC or registrar deducts TDS before crediting the NRO account: 12.5% on equity LTCG (above Rs 1.25 lakh), 20% on equity STCG, and slab (typically 30% plus surcharge) on Section 50AA debt-fund gains. Surcharge in the new regime is capped at 25% even for income above Rs 5 crore, per Finance Act 2025.

To claim the lower DTAA rate where applicable (such as the 15% cap on dividends under Article 10), the NRI must file Form 10F electronically along with a Tax Residency Certificate (TRC) issued by the IRS on Form 6166. CBDT Notification 03/2022 dated 16 July 2022 made the e-filing of Form 10F mandatory; CBDT Circular 6/2024 extended manual filing flexibility for non-resident assessees without a PAN until 30 September 2025. Without a TRC, the AMC withholds at full domestic rates with no treaty relief.

The Section 87A rebate of Rs 60,000 (new regime) for total income up to Rs 12 lakh is not available to non-residents under the proviso to Section 87A; that rebate is reserved for resident individuals. The Rs 1.25 lakh equity LTCG exemption applies separately under Section 112A(2). Use the NRI tax calculator to model the slab plus surcharge plus cess stack for FY 2025-26.

Tax Treatment Abroad

The US is one of the few countries that taxes its citizens and green-card holders on global income. Under IRC Section 61 and Treasury Regulation 1.61-6, a US person reports the same Indian mutual fund gain on Schedule D of Form 1040, computing the gain in US dollars using the IRS yearly average exchange rate (USD-INR averaged 84.97 for calendar year 2025).

The complication is the PFIC regime. Under IRC Section 1297, a foreign corporation is a PFIC if 75% or more of its gross income is passive (the "income test") or 50% or more of its assets produce passive income (the "asset test"). Indian mutual funds, classified as foreign corporations under Treasury Regulation 301.7701-2, fail both tests by definition because their assets are listed securities producing dividends, interest and gains. Form 8621 must therefore be filed for every PFIC held during the year, even if no distribution was received, where the aggregate value exceeds USD 25,000 (USD 50,000 for joint filers) under IRS Notice 2014-28.

A US NRI has three election regimes for each PFIC:

The MTM election is the workable route for most US NRIs, but it converts what India treats as a 12.5% LTCG into US ordinary income at marginal rates up to 37%. The foreign tax credit under IRC Section 901 is computed on Form 1116 using the "passive category income" basket; the credit is the lesser of Indian tax paid and the US tax attributable to the same income. Because Indian LTCG of 12.5% is lower than US ordinary 37%, the FTC almost always partially mitigates rather than fully eliminates US tax. The IRS publishes Form 1116 instructions on irs.gov.

There are two additional disclosure layers. FinCEN Form 114 (FBAR) under the Bank Secrecy Act 1970 must be filed by 15 April each year (with automatic extension to 15 October) when the aggregate value of all foreign financial accounts exceeded USD 10,000 at any point during the calendar year; demat accounts holding Indian MF units count. IRS Form 8938 (FATCA) under IRC Section 6038D applies for unmarried US residents at USD 50,000 (year-end) or USD 75,000 (any time), thresholds doubled for joint filers and quadrupled for US NRIs living abroad. Penalties under 31 USC 5321 for non-wilful FBAR failures are capped at USD 10,000 per violation; wilful failures attract the greater of USD 100,000 or 50% of the account balance.

Repatriation Mechanics

Indian sale proceeds and dividends from mutual funds flow first into the NRO account, since post-tax INR cannot enter NRE without conversion through the repatriation route. Under Schedule III of FEMA Notification 13(R)/2016-RB read with the Master Direction on Remittance of Assets dated 1 January 2016, US NRIs may repatriate up to USD 1 million per financial year from balances held in NRO accounts, after deduction of applicable Indian taxes.

The mechanical sequence is precise. First, the AMC deducts TDS at the rates listed above and credits net proceeds to the registered NRO account at a designated authorised dealer (AD) bank. Second, the NRI engages a chartered accountant to issue Form 15CB certifying that taxes have been deducted. Third, the NRI files Form 15CA online under Rule 37BB of the Income-tax Rules 1962. Fourth, the AD bank executes the SWIFT remittance to the US bank in USD. Fifth, the NRI reports the receipt on Schedule B and (if applicable) Form 8938 of Form 1040, and Schedule D for the underlying gain. The NRI repatriation calculator walks through the USD 1 million ceiling and the documentation stack.

NRE-routed mutual fund investments are different. If the NRI subscribes through an NRE bank account, the fund units are flagged "repatriable" by the AMC, and redemption proceeds go straight back to the NRE account. From NRE, repatriation is unrestricted under Regulation 4 of FEMA 13(R), with no annual ceiling. The trade-off is that subscription must be in fresh foreign currency converted into INR at the time of investment.

For US persons, the FBAR and Form 8938 reporting clock starts from the moment the NRO or NRE balance crosses the threshold, not from the date of remittance. Many US NRIs miss this because they treat the Indian account as "passive" until they repatriate; the IRS does not.

A second technical point on capital losses: Section 70(2) of the Income-tax Act allows STCG losses to be set off against any capital gain, and Section 70(3) allows LTCG losses to be set off only against LTCG, with an eight-year carry-forward under Section 74. The US, under IRC Section 1211(b), allows USD 3,000 of net capital loss against ordinary income each year and an unlimited carry-forward; there is no facility to import an Indian carry-forward into the US tax computation.

For more on cross-border treaty mechanics, see DTAA India-UAE tax residency and treaty shopping. For the property-sale withholding parallel, see NRI Property Sale TDS under Section 195. For rental income, see NRI Rental Income Tax FY 2025-26. The Repatriation glossary entry covers FEMA terms in depth.

FAQ

Are Indian mutual fund gains exempt from tax for US NRIs under the DTAA?

No. Article 13 of the India-USA DTAA dated 12 September 1991, read with Article 13(6), confirms that India retains taxing rights at its domestic rates: 12.5% on equity LTCG above Rs 1.25 lakh, 20% on equity STCG, and slab on Section 50AA debt funds. The US then taxes the same gain under IRC Section 61 and grants a foreign tax credit on Form 1116.

Do I need to file Form 8621 if I only hold one Indian mutual fund?

Yes, if the aggregate value of all PFIC holdings exceeds USD 25,000 (single) or USD 50,000 (joint) at any time during the year, per IRS Notice 2014-28. There is no de-minimis exemption per fund. Annual filing is mandatory even if no distribution was received, under IRC Section 1298(f).

Is a Mark-to-Market election better than the default Section 1291 regime?

For most US NRIs holding Indian equity mutual funds, yes. The Section 1296 MTM election taxes annual unrealised gains at ordinary rates (up to 37% in 2026) but avoids the punitive Section 1291 interest charge that compounds over the holding period. The election must be made in the first year the security is held and is irrevocable without IRS consent under Treasury Regulation 1.1296-1(h).

Can I use the Section 87A rebate of Rs 60,000 against my Indian MF gains?

No. The proviso to Section 87A of the Income-tax Act 1961, retained by Finance Act 2025, restricts the rebate to resident individuals. NRIs pay tax on Indian-source income, including MF gains, without the Rs 60,000 (new regime) or Rs 12,500 (old regime) rebate.

What is the TDS rate on equity LTCG redemption for a US NRI?

Under Section 196A read with Section 112A, the AMC withholds 12.5% on equity LTCG above Rs 1.25 lakh (per PAN, per financial year), plus surcharge (capped at 25% in the new regime under Finance Act 2025) and 4% cess. There is no DTAA relief on this rate because Article 13 leaves capital gains taxation to domestic law.

How much can I repatriate from my NRO account in a financial year?

Up to USD 1 million per financial year per individual, under Schedule III of FEMA (Deposit) Regulations 2016, after producing Form 15CA and Form 15CB. Current-year MF dividend and redemption income net of Indian tax falls within this ceiling. NRE balances are freely repatriable without any cap under Regulation 4 of FEMA 13(R).

Do I need to report Indian MF holdings on FBAR even if I never repatriate?

Yes. FinCEN Form 114 under 31 USC 5314 is triggered by the aggregate value of all foreign financial accounts crossing USD 10,000 at any point during the calendar year, regardless of whether funds are remitted to the US. The demat or folio account holding the MF units is a "foreign financial account" for this purpose. Form 8938 thresholds are separate and additive.