For an NRI who returns back to India, generally speaking (and it can differ from case to case), his residential status remains as a “Resident and Not Ordinarily Resident” (RNOR) for a couple of years post his return. In most of the cases, such NRIs may have investments outside India and they’re not sure what to do with these investments.
Also read: How NRI/PIOs can decode the Indian tax residency rules & save tax
It is here that I believe that an RNOR phase is a GOLDEN WINDOW for such NRIs to help them organize and consolidate their worldwide finances basis their personal financial situation. In my practical work on NRI investment and tax planning, I’ve seen many cases where person did not take advantage of this phase and as a result, is saddled with a huge tax liability when he sells those investments after becoming an RNOR
In this post, I’ll be explaining the tax and FEMA implications of transactions done outside India during RNOR phase and important points/tax planning angles that can be used to legally reduce your tax liability in India at a later point.
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Implication under Income Tax Act
Before moving forward, first let us have a look on what are the implications of doing financial transactions outside India. Kindly note that there will also be tax and other associated implications in the country where your investments are located so also concurrently check with a CPA in that country to plan everything right.
Coming to Indian laws, as per the Income Tax Act, during the financial years where your residential status is RNOR, any overseas income (if not directly received in India) is NOT taxable in India.
This means, that any interest or capital gain or rental income etc. that you earn overseas will be taxed in that country as per its own tax laws but India will not tax it. So, there is no chance of messy double taxation, DTAA relief etc.
Let us understand this with the help of some examples:
#1: You were working in Alphabet Inc. USA and have returned back to India. You were allotted 10000 shares under ESPP plan by your employer. Post your return, during your RNOR phase, you sell all these shares on NASDAQ and take the proceeds in your USA bank account. No tax implication in India.
Also read: Taxation of ESOP/ESPP/RSU/SAR in India
#2: To tweak above example, you give a direction to your broker in USA to credit proceeds to your Indian bank account – entire capital gain will be taxable in India, even if you are an RNOR. In such a situation, since there is a possibility of double taxation, the India USA DTAA may need to be referred to.
#3: You have a property in UAE from which you earn rental income which is credited in your UAE bank account. No tax implication in India till you is an RNOR.
Now please understand that all these incomes which were hitherto not taxable because you were RNOR will become taxable fully in the year from which your residential status turns to ROR.
Also, corresponding changes have been made in Section 139 of ITA making any person having ROR status in India and holding foreign assets/beneficial interest to mandatorily file a return of income in India irrespective of the income in that financial year. A separate schedule named Schedule FSI and FA are given in the tax return where these income/asset disclosures need to be made.
Implication under FEMA
Please understand that FEMA recognises only two residential statuses – “Resident” and “Non-Resident” and has different rules from ITA in deciding a residential status of a person. I’ve discussed this issue in detail in this post: NRI Definition: FEMA Act VS Income Tax Act
So, if you return to India and pick up say an employment in India, you’re classified as a “Resident” under FEMA from the day you return back to India.
FEMA does not concern itself with the taxability of income – that is taken care by ITA. However, RBI wants to ensure that all transactions that a resident does outside India are in compliance with its laid out rules and regulations under FEMA and there are no slippages in receipt of foreign exchange by India.
As per FEMA regulations, a person returning to India and becoming a resident can maintain accounts and investments outside India created out of his earnings outside India. However, as regards “income” earned and received from those investments, FEM (Realisation, Repatriation and Surrender of Foreign Exchange) Regulations, 2015 say that you CANNOT retain the money outside India and need to remit the amount to India within a reasonable time.
In such a case, if you wish to keep the money in $, you can open a Resident Foreign Currency (RFC) account in India and keep in that account. Money in RFC account can be freely repatriated outside India without any restrictions. To know about tax implications of RFC in India, you can check this post: NRO, NRE, FCNR, RFC: Tax and FEMA Implications for Returning NRI
In such situations, please make sure you DO NOT transfer the money in a resident account, because once you do it, you’ll lose free repatriability of that money and will have to explore the LRS route to remit it outside India which requires certain procedural compliances like A-2 form and CA certificate in Form 15CB
Also read: Form 15CA/CB compliances by NRI: Procedure and Issues
Black Money Act implications
In 2015, India enacted Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act (known as Black Money Act). This law is effective July 1, 2015 and requires a person who is a ROR under the ITA to disclose foreign income and assets in his tax return in India. Also Read: Black Money Act: An Analysis
So, while there’s nothing stopping you to do so, there is NO requirement to disclose foreign income and assets in a tax return that you file in India during RNOR phase.
Does it make sense for a returning NRI to consolidate his foreign investments during RNOR phase?
While it depends from situation to situation, in my view, for a returning NRI who has a clear cut thought process of settling back in India and don’t have financial goals which require money in non-INR currency, there is a STRONG CASE for liquidating foreign investments and shifting it to India and using the RNOR phase to do all of this, to avoid any tax incidence in India.
My reasoning for the above basis my experience in dealing with several returning NRIs is as follows:
- Income from those investments will be taxable in India as well after you turn as ROR:
The problem that arises if you continue to maintain investments outside India AFTER you cross the RNOR phase and become an “Resident and Ordinarily Resident” (ROR) – if and when you become an ROR, India will also get the right to tax your worldwide income irrespective of the fact that you have already been taxed on that income outside India.
- DTAA does not nullify double tax impact fully:
Now, your point may be, that you have read over the internet that there is something like a DTAA and can help you avoid double taxation, please note that when you practically try to apply DTAA, there are “n” number of teething issues and grey areas in it and it is a highly interpretative subject – you and your CA might make certain reasonable interpretations of DTAA however the Income Tax Department and courts can take a completely different view – I’ve covered one such case where our Raees Bolloywood superstar SRK’s claim that UAE property income is exempt, was rejected by ITAT Mumbai . If this can happen to SRK who hires top notch lawyers to defend him, who are you and IJ – read it here: Shah Rukh Khan [ITAT] – Income from UAE property is taxable in India
Asides, below are three reasons why DTAA does not nullify double tax in a 100% way:
- If you earn income from an investment in say USA, USA will tax you for the entire capital gain as per US tax law however India will give a credit in that year’s tax return ONLY on the portion of income from that investment as disclosed by you and which results for that particular year
- India will give you a credit on the lower of the rate that that income gets taxed in India and the rate on which tax is paid in USA. So, if your tax rate in India is 30% and the tax deducted in say USA is at 20%, you will be first taxed in India at 30% and you’ll get the credit of only 20% (and not @ 30%)
- There are certain taxes in foreign countries that are not recognised in the DTAA. Prime example is the tax structure in USA – India does not recognise and will not give credit for social security, state tax and medicare tax that one pays in USA – the credit is only available w.r.t. the federal income tax.
- You will be exposed to currency risk if there is a mismatch between your investment currency and financial goal:
When you make an investment, ask yourself what is the purpose – so, when you invested significantly in US shares/401K 10 years ago, you had in mind that you’ll settle there.
Now that today you have a family and children growing up and decide to retire to India permanently, you need to “evaluate” the investment logic afresh – because if you don’t and there is a mismatch between the currencies of investment vis a vis currency of fund requirement, you expose your investment portfolio to currency risk.
While INR has steadily depreciated against USD for past decades, it is not the same for other currencies so you need to think from that angle as well.
I’ve also discussed this issue in detail in this post you can check: How NRI/PIO families can manage exchange rate risk in their investments
- You’ll need to file complex tax return in India every year:
After RNOR phase is over and you become an ROR, even if you do not have reportable income in India above the qualifying exemption limit (especially in cases where person is retiring in India or homemakers who do not take up a job in India), you need to continue filing an income tax return.
Speaking of the tax return, you need to select the return type which allows you to disclose foreign income and assets. You need to convert the foreign income into INR as per Rule 115 of ITA and ensure correct disclosure.
Major pain awaits in submitting a tax residency certificate to the foreign deductor– many a times, even after you submit (e.g. a W-8BEN as required under US tax code) and get a confirmation from say your broker in USA, they end up paying you after withholding tax – in such cases, computing the relief under DTAA is not easy.
If this proves too technical for you and you hire a CA for this job, you need to select one that possesses sufficient expertise in international taxation. Plus, CA will charge a premium fee in view of the complexity involved.
- There may be an implications under Black Money Act:
If filing foreign income tax returns seem painful, read this: if due to a mistake by you to disclose the incomes correctly (many a times, people hinge on certain interpretation of taxability of foreign income in India till a professional CA awakes them), note that the undisclosed foreign income is liable to tax not under ITA but under Black Money Act (BMA) – BMA is a severe and draconian law by any standard that pre-supposes a person’s culpable state of mind in case of non-disclosure and implication can be: Flat penalty of INR 10 lacs, tax charge at 30% and a jail term up to 10 years
In one of my posts, I had covered a real life case where person failed to disclose and report correct income after becoming ROR: 401K non-disclosure in Indian tax return: Implications
If you plan to defend your case in litigation, you need to also consider the fees a CA will charge to defend you.
Also note that whereas if it is an undisclosed black money in India, you can disclose it u/s 115BBE in India (Also read: New Section 115BBE and 271AAC of Income Tax Act – Important points and How can NRI safely disclose his undisclosed income (black money) in India) however no such relief is available for undisclosed “foreign” income because BMA does not contain any such provision. In such case, the advice is to pray a lotJ
- Issues may arise in case of succession planning
This issue is relevant for people who have large inheritances and have joint families and/or there is a possibility of family dispute on the assets after death. Those NRIs need to be also careful about the succession aspects of such investments outside India.
While any property in India is governed by clear cut succession laws of India, or you can have a will specifying the distribution as per your desire, note that the same does not apply for assets located out of India. Foreign courts may not recognise your Indian will and treat the death as intestate and proceed to distribute as per its own succession law.
Classic case is that of UAE: As far as what I know (and I am not an expert on UAE succession laws) – it is said that if you die in UAE, the court immediately (within a few hours) freeze bank accounts (unlike India where nominee can show ID proof and get the money) – then, they proceed to distribute the assets as per Sharia law that prescribes a very different distribution rule as compared to India. Alternative is a proper will registered by DIFC – and one of my clients told me, it can cost upwards of INR 2.5 lacs.
Now take example of UK: UK applies inheritance tax at a flat rate of 40% on estate valued upwards of £ 3,250,000 – similar to this, USA also applies estate tax however there the lifetime limit is really really high – $ 54,50,000
So, the broad point I’m trying to make is that if the value of estate is large, those considerations also come into play and if you wish to retain investments, you must sit with an attorney & prepare an estate plan.
Important pointers for returning NRIs who are in RNOR phase
There is a phrase in Hindi -“ab pachtaye hot kya jab chidiya chug gayi khet” (what will happen by crying now when birds have already eaten the crop)
I believe RNOR is the best opportunity for a returning NRI to align their investments with their financial goals and reduce India tax liability before he become ROR and his worldwide income starts getting taxed in India.
Below are some pointers I wish to share in this regard:
- Take a call on your overseas investments NOW:
RNOR is the time where you need to take stock of your investment outside India. You need to ask yourself questions like:
- This investment relates to which financial goal?
- Is the currency of the investment same as what I will need the money in, when the financial goal matures?
- What is the risk profile of the investment? Does it fit into my overall asset allocation? (a very important question)
- What will be the India taxation of the income after I become ROR?
- Will I be eligible to claim DTAA relief of tax paid in foreign country? If yes, how much?
- Is the transaction allowed under FEMA?
- What is the local tax liability on this transaction?
Basis the answers of these questions, you should get a fair idea on what to do with the investment. However, the practical challenge is that it requires a multidimensional analysis from all angles and hence it may be better to rope in a professional on both sides (India as well as foreign country) to obtain the right advice.
- DO NOT make the mistake of crediting the income in Indian bank account:
I’ve seen quite a few NRIs making this fatal mistake. When winding up everything and returning to India, there is also a tendency to close foreign bank account and update India address and bank details in the investments.
After return, when money is directly credited in India, apart from tax withholding in foreign country, income from that investment will be taxable in India irrespective of your residential status on receipt basis as discussed earlier in the article. Yes, w.r.t. salary income, you can take an argument that India can tax it ONLY if it pertains to services rendered in India but who would want to end up in litigation with tax department.
In a recent real life case, I started on the case for investment planning for a USA based NRI who just returned to India and had updated Indian bank account – I immediately requested him to cancel it and take the money in foreign bank account. Luckily, there was a delay on the part of the US broker to process his transaction and he could get the credit in US bank account.
Hence, returning NRI need to keep following important things in mind during RNOR phase:
- Never take credit of overseas income directly in Indian bank account – route it through a foreign bank account
- Even after doing the transaction, keep your foreign bank account live till near to end of RNOR phase – you never know which investment you might have forgotten needs to liquidated – the foreign bank account will come in handy in such case.
- Close the account before ROR begins else you will need to disclose it in tax return in Schedule FA.
- Reset the cost of acquisition of outside India investments:
If you wish to retain your foreign investments after becoming an ROR, a very sound and legal tax planning strategy to minimise tax implication in India can be to sell all holdings just before the RNOR period ends (before March 31 of the last RNOR year) and then re-purchase all units/shares. This can be in exactly the same ratio or in a different ratio, from your asset allocation perspective or as suggested by your investment adviser.
What this will do is that it will help reset the “cost of acquisition” for capital gains computation purpose in India. So, when you sell that investment later after becoming ROR, the higher cost of acquisition for capital gain computation will result in a lower tax liability in India. If this transaction is done during RNOR period, there will not be any tax incidence in India.
However, before employing this strategy, please keep in mind following points:
- This strategy will only apply to those investments that qualify as “capital asset” in India – examples can be shares, mutual funds, bonds, 401K, etc.
- You need to also keep in mind tax implication of this transaction in foreign country. Talk to your CPA.
- This strategy will work only in a rising market – in a falling market, it can actually backfire and increase your capital gains tax liability in India.
- After doing this reset, you will have to wait for at least 24/36 months (depending on the nature of asset) from this reset date before selling, so that the gain on sale qualifies for long term capital gain and accordingly subjected to a reduced 20% tax rate.
- The time to hire a tax and investment adviser is NOW:
The first question I ask a returning NRI is – what is your residential status as per Income Tax Act? Because, if you hold foreign investments and wish to take a call after becoming ROR, you lose the golden window of opportunity that you get during RNOR phase to structure those investments in your favour.
Though it cannot be a general rule, but as per my experience I can say that the maximum value that a returning NRI gets out of hiring an NRI tax adviser is when he is either in non-resident or RNOR status – after ROR, even the adviser cannot do much by way of tax structuring and the focus shifts to whether proper compliances are being made under BMA which no doubt is a superb value addition, but of a different sort.
So, in my view, a returning NRI has to first decide whether he needs professional advice and if yes, he should not dilly dally and hire an adviser once his return to India plans are finalized and he is close to either start of RNOR phase or in the middle – earlier the better, as it will give both him and adviser a wider window and better space out the investment and tax decisions within the length of the RNOR phase.
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