High Value Transaction Notice - NRI Mutual Fund Redemptions

The Problem

An NRI based in the UK received an income tax notice under Section 142(1) for AY 2022-23. The Annual Information Statement (AIS) showed mutual fund redemptions of ₹38 lakhs during the year — flagged as high value transactions not reflected in any ITR.

The notice asked for an explanation of the source of these funds and why no income tax return had been filed. The client was concerned because TDS at 20% had been deducted by the mutual fund house, and she believed this discharged her tax obligation in full. She had not filed an ITR in India for several years.

Why This Happens

Under Section 206AA, if a non-resident investor does not provide their PAN to the mutual fund, TDS is deducted at 20% on redemptions — irrespective of the actual capital gain. When AIS (which tracks all SFT-reported transactions) shows large redemptions and no corresponding ITR, the system automatically generates a compliance notice. The fact that TDS was deducted does not prevent the notice — it merely means a refund may be due.

What We Did

Establishing Residential Status We verified the client's residential status for FY 2021-22. She had spent 18 days in India that year (family visit). Under the Income Tax Act, with fewer than 60 days in India, she qualified as a Non-Resident. We compiled passport stamp records and boarding passes as evidence.

Capital Gains Computation The ₹38L in redemptions was not all capital gain — it included the original invested capital. We obtained the mutual fund account statement from CAMS showing:

• Original investment: ₹28L (across three equity funds, invested in 2018–19)
• Redemption proceeds: ₹38L
• Long-Term Capital Gain (held > 1 year): ₹10L

DTAA Analysis (India-UK) Under the India-UK DTAA, capital gains on listed securities (equity mutual funds are treated as listed securities) by a UK resident are taxable only in the UK — India does not have taxing rights under the treaty. We prepared a DTAA analysis memo and obtained the client's UK Tax Residency Certificate.

ITR-2 Filing We filed an ITR-2 for AY 2022-23 declaring the capital gains, claiming NRI status and DTAA exemption for the gains, and claiming full TDS credit. The result: zero tax payable and a refund of the entire TDS of approximately ₹7.6L.

Response to the 142(1) Notice We filed a detailed response attaching the ITR, residential status evidence, DTAA memo, TRC, and capital gains computation.

The Result

The AO accepted the submissions. No tax demand was raised. The refund of ₹7.6L (excess TDS) was processed within three months.

Key Takeaway: NRI investors in Indian mutual funds should file ITR every year in which they redeem units — even if TDS has been deducted. The ITR enables claiming DTAA exemption, computing the actual gain (not gross proceeds), and recovering excess TDS.