Why NRIs Get TDS Deducted on Every Mutual Fund Redemption (When Residents Pay Nothing at Source), How Much It Is, and How to Stop Over-Paying

A reader in Dubai sold an equity fund he had held for six years, expecting a clean Rs 6,00,000 long-term gain to land in his account with little or no tax, because he knew the first Rs 1.25 lakh of long-term equity gain is exempt and the rest is taxed at just 12.5%. What actually arrived was about Rs 78,000 lighter than he expected. The AMC had deducted tax at source on the entire gain, ignored the exemption, and paid him the rest. Nothing had gone wrong. This is exactly what the law tells the fund house to do for an NRI, and it is exactly what does not happen to the resident sitting next to him who sold the same fund on the same day and received every rupee of his redemption untouched.

The 30-second answer: When a resident redeems Indian mutual fund units, no TDS is deducted; they self-assess the gain and pay it when they file. When an NRI redeems, the AMC must deduct tax at source on the capital gain under Section 195 read with Section 115AD, before paying out. For equity funds after 23 July 2024 that is 12.5% on long-term gains and 20% on short-term, plus surcharge and 4% cess; debt and non-equity gains are taxed at slab rates. The deduction is on the gain, not the whole amount, but AMCs usually ignore the Rs 1.25 lakh exemption and cannot net losses, so you over-pay and reclaim by filing a return. A Section 197 certificate (Form 13) or a DTAA rate (TRC plus Form 10F) cuts the deduction at source.

This guide is about one structural fact that surprises almost every NRI the first time it bites: the residential status on your folio changes what happens at the moment of redemption, not just what you eventually owe. A resident and an NRI can hold the identical fund, realise the identical gain, and walk away with different amounts in hand on the same day, before either of them has filed a single form. What follows is why that gap exists, exactly how much the AMC withholds in 2026 across equity and debt, where the over-deduction creeps in, the full arithmetic on a Rs 6,00,000 equity gain set against what a resident would receive, and the four levers that reduce the bite or get your money back.

The split happens at the point of sale, not at filing

Start with the resident, because the resident is the simpler case. When a resident investor redeems mutual fund units, the AMC pays out the full redemption value. Not one rupee is withheld. The capital gain is real and it is taxable, but the law leaves the resident to compute it and pay it when filing the annual return. The system trusts the resident to self-assess. The only thing the AMC reports is the transaction to the tax department through the statement of financial transactions, which is why the gain shows up in the resident's Annual Information Statement. The cash, though, arrives whole.

Now the NRI. The instant a folio is flagged as non-resident, a different machine takes over. Section 195 of the Income Tax Act requires any person paying a sum to a non-resident that is chargeable to tax in India to deduct tax at source before making the payment. A capital gain on Indian mutual fund units is income that accrues in India and is chargeable here, so it falls squarely inside Section 195. The AMC, as the payer, has no discretion. It must withhold and deposit the tax with the government, and only the balance reaches you. Read together with Section 115AD, which sets the rates at which a non-resident's capital gains on securities are charged, this is the legal spine of every deduction you see on an NRI redemption statement.

The reason for the asymmetry is collection risk, plainly stated. A resident is inside the Indian tax net and can be assessed, pursued, and penalised if the self-assessed gain is never paid. A non-resident may have no other Indian income, no ongoing filing habit, and no easy enforcement once the money has left the country. So the law collects at source while it still controls the cash. That is the whole logic. It is not punitive in intent, but the practical effect is that the NRI hands over the tax first and argues about the correct amount later, while the resident does the opposite.

One clarification that saves a lot of panic. The TDS is deducted on the capital gain, not on the full redemption value. If you redeem Rs 20,00,000 worth of units that cost you Rs 14,00,000, the gain is Rs 6,00,000 and the deduction is computed on that Rs 6,00,000, not on the Rs 20,00,000. Your own capital coming back is not taxed and is not withheld against. AMCs and their registrars (CAMS and KFintech do this for most fund houses) compute the gain unit by unit using first-in, first-out matching, apply the rate, and net the tax out of the payout. The mechanic is correct; the friction, as we will see, is in the rate they apply and the exemption they skip.

What the AMC actually deducts in 2026

The rates split by the type of fund and the holding period, and the regime changed materially on 23 July 2024, so anyone working off older numbers will be wrong.

For an equity-oriented fund (broadly, a fund holding at least 65% in Indian equities, where the units are subject to securities transaction tax), the holding period that separates short-term from long-term is 12 months.

• Held more than 12 months, the gain is long-term and taxed under Section 112A at 12.5%. The AMC deducts 12.5% on the long-term gain.
• Held 12 months or less, the gain is short-term and taxed under Section 111A at 20%. The AMC deducts 20% on the short-term gain.

On top of the base rate sit two add-ons. Surcharge applies where your total Indian income crosses the relevant thresholds (10% above Rs 50 lakh, 15% above Rs 1 crore, with capital gains surcharge capped at 15%), and a 4% health and education cess applies on the tax plus surcharge. For most NRIs redeeming a modest gain, surcharge is nil and only the 4% cess applies, so the effective deduction on a long-term equity gain is 12.5% plus 4% cess, or 13% of the gain.

For a non-equity or debt-oriented fund, the picture is harsher and was reshaped twice. Debt funds bought on or after 1 April 2023 lost indexation and the special long-term rate entirely: the gain is treated as short-term regardless of how long you held it and is added to your income, taxed at slab rates. For the NRI this means the AMC deducts at the maximum marginal rate applicable to that category, which in practice is the 30% slab plus surcharge and cess for the specified-rate withholding on a non-resident, unless a lower rate is certified. Gold funds, international funds, and other non-equity vehicles generally fall on this side of the line. The single most expensive mistake an NRI makes here is assuming the friendly 12.5% applies to a debt or gold fund. It does not. Only equity-oriented funds get the 12.5% and 20% rates; everything else is taxed at slab and withheld accordingly.

A table makes the contrast clean.

Fund type	Holding period	Tax rate on gain	What the AMC withholds from an NRI
Equity-oriented	More than 12 months (long-term)	12.5% under Section 112A	12.5% on the gain, plus surcharge and 4% cess
Equity-oriented	12 months or less (short-term)	20% under Section 111A	20% on the gain, plus surcharge and 4% cess
Debt or non-equity (units bought on or after 1 Apr 2023)	Any period	Slab rate, treated as short-term	Withheld at the specified high rate, up to 30% plus surcharge and cess

And the line that the whole guide turns on, repeated because it is the part people forget: a resident redeeming any of the above has zero deducted at source. The rate column above describes what they will eventually pay when they file. The withholding column describes what an NRI loses from the payout on the day.

Where the over-deduction creeps in

The deduction being on the gain is fair. The way AMCs compute that deduction is where NRIs systematically over-pay, and it happens in three predictable places.

First, the Rs 1.25 lakh annual long-term exemption is usually not applied at source. The law gives every taxpayer a Rs 1,25,000 annual exemption on long-term equity gains under Section 112A; only the gain above that is taxed at 12.5%. But an AMC deducting on a single redemption has no way of knowing how much long-term equity gain you have already realised this year across other funds and other fund houses, so to stay safe it deducts 12.5% from the very first rupee of long-term gain, ignoring the exemption entirely. On a Rs 6,00,000 long-term gain your true taxable amount is Rs 4,75,000 (after the Rs 1.25 lakh exemption), but the AMC withholds against the full Rs 6,00,000. That single omission is the most common reason the payout lands lighter than expected.

Second, the AMC cannot net your capital losses. If you booked a Rs 2,00,000 loss on one fund and a Rs 6,00,000 gain on another, your net taxable gain is Rs 4,00,000. The fund house deducting on the winning redemption knows nothing about the losing one, possibly held at a different AMC, so it withholds on the full Rs 6,00,000. Loss set-off only happens in your return. Through a year of multiple redemptions, the gross-by-gross withholding can far exceed the tax on your net position.

Third, the AMC deducts at the domestic rate, not your treaty rate, unless you have given it the paperwork. A favourable DTAA rate is not automatic. Absent a Tax Residency Certificate and Form 10F on file, the AMC applies the domestic Section 115AD rate. For equity gains that domestic rate is usually already the lowest available, so the treaty rarely helps here, but for the debt and dividend side it can matter a great deal.

The cumulative effect is a float you give the government interest-free. Across a year of redemptions you can easily have a lakh or more sitting with the Income Tax Department, money that is genuinely yours, that you recover only after the financial year ends and you file. This is not a tax cost in the end. It is a cash-flow cost, and on a large or frequently traded portfolio it is a real one. The good news is that all of it is recoverable, and two of the three leaks can be plugged before the deduction even happens.

How you get the excess back: file the return

The recovery route is the annual Indian income tax return, and it is mechanical once you understand the moving parts.

When you file, you compute your actual capital gains tax for the year. You apply the Rs 1.25 lakh long-term equity exemption. You set off any eligible capital losses, short-term losses against any gains and long-term losses against long-term gains, and carry forward what you cannot use. You apply the correct slab and surcharge to your total Indian income. The number you arrive at is your true liability.

Against that liability you claim full credit for the TDS the AMC deducted. Every rupee withheld under Section 195 is reported by the AMC to the tax department and appears in your Form 26AS and your Annual Information Statement, keyed to your PAN. The return pulls these in. Where the TDS exceeds your computed tax, the difference is refunded with interest under Section 244A, paid into the Indian bank account linked to your PAN. For this to work you need a valid PAN, the folio held against that PAN, and an active NRO or NRE bank account to receive the refund.

This is why a PAN and a filing habit are not optional for an NRI who invests in Indian funds. The AMC cannot refund you once it has deposited the tax with the government; the only door back to your money is the return. An NRI who redeems, takes the net, and never files is simply making a gift to the exchequer of every rupee of over-deduction. The deadline for the return is the usual 31 July following the financial year (extendable in some years), and the refund typically lands within a few weeks to a few months of filing and verification. The full step-by-step on credit, refunds, and timelines is in TDS for NRIs and how to claim refunds.

Worked example: a Rs 6,00,000 equity gain, NRI versus resident

Take the Dubai reader from the opening. He redeems an equity-oriented fund held for six years and realises a long-term capital gain of Rs 6,00,000. Surcharge does not apply because his total Indian income for the year is well under Rs 50 lakh. Watch what each party walks away with.

The resident, on the same fund and the same gain:

• TDS deducted at source: Rs 0.
• He receives his full redemption value on the day.
• When he files, his taxable long-term gain is Rs 6,00,000 minus the Rs 1,25,000 exemption, so Rs 4,75,000.
• Tax at 12.5% on Rs 4,75,000 is Rs 59,375, plus 4% cess of Rs 2,375, total Rs 61,750.
• He pays that Rs 61,750 out of pocket at filing, having had the use of the full redemption in the meantime.

The NRI, identical fund, identical Rs 6,00,000 gain, no Section 197 certificate on file:

• The AMC ignores the Rs 1.25 lakh exemption and deducts 12.5% on the full Rs 6,00,000: that is Rs 75,000, plus 4% cess of Rs 3,000, total Rs 78,000 withheld at source.
• He receives his redemption value minus Rs 78,000 on the day. This is the roughly Rs 78,000 shortfall that surprised him.
• His true liability, identical to the resident's, is Rs 61,750 (12.5% on Rs 4,75,000 plus cess), because he is entitled to the same Rs 1.25 lakh exemption.
• He files his Indian return, claims credit for the Rs 78,000 TDS shown in Form 26AS, and his computed tax is Rs 61,750.
• The excess of Rs 16,250 (Rs 78,000 withheld minus Rs 61,750 owed) is refunded with interest under Section 244A.

So the end state for the resident and the NRI is the same tax of Rs 61,750. The difference is entirely in timing and effort. The resident never lost the use of a rupee and pays once at filing. The NRI lost Rs 78,000 on the day of sale, recovers Rs 16,250 months later, and had to file a return to do it. The Rs 16,250 sat with the government interest-free until the refund (the Section 244A interest softens, but does not erase, the drag). If the same NRI had a Rs 2,00,000 capital loss elsewhere to set off, the gap would be wider still: his true tax would fall to roughly 12.5% on Rs 2,75,000 plus cess, about Rs 35,750, against the unchanged Rs 78,000 withheld, leaving over Rs 42,000 to reclaim. Every rupee is recoverable. None of it is automatic.

Edge cases

The general rule, TDS on the gain at 12.5% or 20% for equity and slab rates for debt, holds for the standard redemption. Several situations change the calculus, and they are where money is most often left on the table.

The Section 197 lower-deduction certificate (Form 13). This is the strongest lever, and it works before the deduction rather than after. You apply to the Assessing Officer, usually before or early in the financial year, with your estimated income and gains. The officer issues a certificate specifying the exact lower rate (or nil) at which the AMC should deduct, reflecting your real liability after the exemption and any losses. You hand the certificate to the AMC and it withholds at the certified rate. For a large planned redemption, say liquidating a Rs 50 lakh corpus, this converts a painful over-deduction into the right number at source and removes the refund wait entirely. It takes a few weeks to obtain, so plan it ahead of the sale, not after. The mechanics are in the lower TDS certificate and Form 13 guide.

The DTAA rate (TRC plus Form 10F). A tax treaty can lower the rate the AMC applies, but only if you have filed a Tax Residency Certificate from your country of residence and a Form 10F with the AMC. For equity capital gains, most Western treaties do not beat the 12.5% domestic rate, so this lever matters less for equity redemptions and more for dividends and for debt-fund and interest income, where treaty rates can be materially lower. Gulf residents in particular should check, because the UAE has no personal income tax and the treaty interaction is specific. The full treaty machinery is in DTAA mechanics, TRC and Form 10F.

The Rs 1.25 lakh exemption at source. As covered above, AMCs generally do not apply it. There is no reliable way to force a fund house to honour the exemption on a single redemption, because it cannot see your full-year position. The two clean answers are a Section 197 certificate that bakes the exemption into the certified rate, or simply accepting the over-deduction and reclaiming the exemption in your return. Do not assume a low-value redemption escapes deduction; the AMC will withhold on the gain even where your eventual tax, after the exemption, is nil.

Debt funds. Worth restating because the cost is so different. For debt and non-equity units bought on or after 1 April 2023, the gain is taxed at slab rates with no long-term concession, and the AMC withholds at a high specified rate. There is no Rs 1.25 lakh equity exemption to fall back on. If you hold both equity and debt funds, expect the debt redemptions to be withheld far more heavily, and budget for it. The over-deduction logic still applies, and you still reclaim any excess by filing, but the base is harsher.

SWP and frequent redemptions. A Systematic Withdrawal Plan is not a special case in law; each withdrawal is a partial redemption, and TDS is deducted on the gain portion of every single payout. Twelve withdrawals a year means twelve deductions, each ignoring the annual exemption, so the cash-flow drag compounds across the year. This is the single biggest argument for getting a Section 197 certificate if you run a meaningful SWP. The full treatment, including the part-capital-part-gain mechanic and how FIFO decides the rate, is in the NRI systematic withdrawal plan guide.

US and Canada residents have a second tax system watching. If you are tax-resident in the US or Canada, the Indian TDS is only half the story. Your Indian mutual funds are almost certainly passive foreign investment companies (PFICs) in US eyes, with their own punitive reporting and tax regime that runs in parallel to the Indian one, and Canada has its offshore-fund rules. The Indian TDS you suffer becomes a foreign tax you may credit at home, but the PFIC overlay can make the whole holding more expensive than it looks. Do not plan an Indian redemption in isolation if you are in those countries; read the US NRI Indian mutual funds PFIC trap first, and on the credit side, foreign tax credit and Form 67.

The closing read

The honest read is that the TDS on your redemptions is not an extra tax, it is the same tax a resident pays, collected from you at a worse moment and often in too large an amount. You will not, in the end, pay a rupee more than the resident on the identical gain. But you will lose the use of the money for months, you will frequently have the Rs 1.25 lakh exemption ignored and your losses unnetted at source, and you will only get the excess back if you file an Indian return. The single behaviour that protects you is filing, every year, claiming the TDS credit shown in your Form 26AS and reclaiming the over-deduction with interest.

For most NRIs with modest, occasional equity redemptions, the right posture is to accept the over-deduction, keep a clean record of cost basis and gains, and reclaim by filing. For anyone planning a large redemption or running an SWP, get a Section 197 certificate ahead of the sale; it is the difference between losing Rs 78,000 on the day and losing the correct Rs 61,750, with no refund wait. And if you are tax-resident in the US or Canada, never plan the Indian side alone, because the PFIC and offshore-fund regimes can dwarf the Indian TDS entirely. The deduction is the law doing its job. The over-deduction is the part you are allowed, and expected, to fix.

Related guides

• Capital gains tax for NRIs on shares and mutual funds
• TDS for NRIs and how to claim refunds
• The lower TDS certificate and Form 13
• Foreign tax credit and Form 67
• DTAA mechanics, TRC and Form 10F
• NRI mutual fund eligibility
• Running an SWP from Indian mutual funds as an NRI
• Tax-efficient investing for NRIs
• NRI portfolio asset allocation
• NRI residency and the RNOR rules
• The US NRI Indian mutual funds PFIC trap

Disclaimer

This guide is general information, not tax or investment advice, and it reflects the rules as understood in 2026, including the capital gains regime effective 23 July 2024. Rates, surcharge thresholds, exemption limits, and treaty positions change, and the right treatment depends on your specific residential status, country of residence, fund type, and full-year income and losses. TDS, Section 197 certificates, DTAA relief, and refund claims are statutory matters with real consequences for getting them wrong. Confirm your position with a qualified chartered accountant or cross-border tax adviser, and where the US or Canadian PFIC and offshore-fund regimes apply, take advice in that country too, before you redeem or file.