Indian mutual funds and the UK offshore non-reporting fund trap

This is the trap that catches almost every UK resident with Indian funds. UK tax splits offshore funds into reporting funds, whose gains are capital gains, and non-reporting funds, whose gains are taxed as income. To be a reporting fund, the fund must apply to and report to HMRC, and Indian mutual funds essentially never do, so they are non-reporting funds.

The consequence is that when you sell an Indian fund, the profit is an offshore income gain, charged to income tax at your marginal rate, up to 45%, not the lower capital-gains rates. You also lose the annual capital-gains exemption, because this is not a capital gain at all, and the gain stacks on top of your income, which can push you into a higher band. There is even an asymmetry that hurts: if a fund falls and you sell at a loss, that loss is treated as a capital loss, so it cannot be set against the income gains on your winning funds. So the upside is taxed as income and the downside is only a capital loss, usable against other capital gains but not against the income gains.

One exception: if you moved to the UK after at least 10 consecutive years abroad, the FIG regime can keep offshore income gains out of UK tax for your first four UK tax years if you claim it, though claiming costs you your personal allowance and CGT annual exempt amount for that year, and India still taxes the gain. Our FIG regime page covers it.

India taxes the same redemption in its own right. For equity funds, long-term gains over ₹1.25 lakh are taxed at 12.5% and short-term gains at 20%, for sales on or after 23 July 2024. Debt-fund units bought on or after 1 April 2023 are taxed at your slab rate however long you hold them, while older debt units held over two years are taxed at 12.5%. The fund house deducts TDS on an NRI's redemption. The India-UK treaty leaves capital gains to each country's own law, so it does not lower this TDS. Any excess over the actual tax is reclaimed on an Indian return, or cut in advance with a lower-deduction certificate (Form 128 under Section 395, formerly Form 13).

Distributions from equity funds are taxed in the UK as dividends, at up to 39.35% with only the small £500 dividend allowance, while distributions from debt funds are usually taxed as interest at your savings rates. India's withholding is credited in the UK. To get India's treaty rate on these payouts, give the fund house a tax residency certificate and Form 41 (formerly Form 10F). On the capital side, the UK gives credit for the India tax on the redemption too, but here is the sting on top of the sting: the India tax was charged as capital-gains tax at 12.5% or 20%, while the UK is charging income tax at up to 45% on the offshore income gain, so the India credit frequently falls well short of the UK bill. A practising CA computes the Indian gain and TDS correctly, reclaims any excess, and gives your UK accountant the India-tax-paid figures, but the offshore-fund status itself is a UK-side fact worth planning around before you invest.