For an NRI it is a pain to understand the tax nuances for non-resident accounts. Situation becomes more troublesome when he returns to India as the taxation differs as per the residential status. In this post, I am offering a detailed overview of tax and FEMA compliances and implications on various accounts.
Also, as far as tax is considered, I am giving below a comparative list on tax treatment of different accounts as per a person’s residential status as per IT Act:
Tax Rules on Non-Resident Accounts
Under the Income Tax Act, Section 10 contains a list of incomes which are EXEMPT. The relevant provisions are reproduced below:
Section 10 (4): Pertaining to NRE:
(4) …………
(ii) in the case of an individual, any income by way of interest on moneys standing to his credit in a Non-Resident (External) Account in any bank in India in accordance with the Foreign Exchange Management Act, 1999 (42 of 1999), and the rules made thereunder :
Provided that such individual is a person resident outside India as defined in clause (q) of section 2 of the said Act or is a person who has been permitted by the Reserve Bank of India to maintain the aforesaid Account ;
Section 10(15): Pertaining to FCNR/RFC/RFC(D):
(15)…..
(iv) interest payable—………..
(fa) by a scheduled bank to a non-resident or to a person who is not ordinarily resident within the meaning of sub-section (6)† of section 6 on deposits in foreign currency where the acceptance of such deposits by the bank is approved by the Reserve Bank of India.
Explanation.—For the purposes of this item, the expression “scheduled bank” means the State Bank of India constituted under the State Bank of India Act, 1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959), a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980), or any other bank being a bank included in the Second Schedule to the Reserve Bank of India Act, 1934 (2 of 1934), but does not include a co-operative bank;
As regards Indian tax rules for residential status, please read my post: How NRI/PIOs can decode the Indian tax residency rules & save tax Link
FEMA Rules on Non Resident Accounts
Following are the links to the applicable regulations on this date 05/10/2016. Note that these regulations keep changing every year so head up to the RBI website to download the most recent.
- FEM (Foreign Currency Accounts by a person resident in India) Regulations, 2016 Link
- FEM (Deposits) Regulations, 2016 Link
- Mater Direction – Deposits and Accounts Link
Implications for Returning NRI
The moment you re-designate your accounts in compliance with FEMA, the entire tax treatment on the investments change. You need to be aware of this because you don’t want a situation where you fail to offer an income which is liable to tax in India and thus invite penalty/prosecution from the Indian tax authorities just because you were “unaware” of the law and how it works in India. Remember the cardinal principle: Ignorance of law is not an excuse.
#1: Non Resident Ordinary (NRO):
- If you have a resident bank account, you will need to convert it to an NRO account on becoming an NRI as per FEMA.
- You will have to again convert this account to a resident account on return to India.
- Interest earned from this account is taxable.
- A tax deducted at source (TDS) will be applicable @30% from the interest income.
- You are not allowed to submit Form 15G/H to avoid TDS.
- If you want to claim lower rate of TDS, you can check India’s Double Taxation Avoidance Agreement (DTAA) with the country of which you are a tax resident. Your bank may ask for a proof of residency in the form of a Tax Residency Certificate (TRC) issued by your country of residence.
- You can file a tax return at the end of the year and claim an adjustment of TDS in your tax liability.
- If the amount in NRO is huge (for example, receipt of insurance claim or sale proceeds of property have been credited in this account), you should explore an option to transfer money from NRO to NRE account – there is a limit of USD 1 MN per financial year for doing that plus it requires Form 15CA Form 15CB to be furnished to the bank.
- Think twice before investing or buying insurance by paying from NRO account as you will not be allowed to repatriate that money. Instead, use NRE account.
#2: Non Resident External (NRE):
- If you become an NRI as per FEMA, you can open this account to deposit your overseas earnings.
- It is NOT mandatory to open this account however if you are likely to earn outside India for significant time and want the money to be repatriable, you should consider opening this account & deposit your overseas earnings in this account and not in the NRO account.
- You should use this account to make mutual fund/stock investments or purchasing insurance policies if you wish the money to be repatriated out of India.
- The amount in this account is completely tax free under Section 10(4)(ii) of the Income Tax Act (as discussed above) till the time you are a NRI. The moment you return back to India, you will have to re-designate account to “resident” and it will be taxable as a normal bank account.
- After your return to India, your bank will allow you to run your NRE deposits till maturity.
- FEMA requires that on return to India, money standing to credit of NRE should be either moved to an RFC account after return or to a resident FD: you will have to make a choice more from an exchange risk perspective than the taxation angle.
- Since interest is tax free, there is no question of TDS. Even after your return to India, bank will continue to deduct zero TDS but this does not mean these deposits are tax free – if you’ve opted for converting them to resident FD, you will have to offer income in your tax return.
- As far as rate of tax is considered, you can take benefit of special provisions of the IT Act for non-residents & claim a concessional rate of 20.60% u/s 115I of Income Tax Act for this income after your return to India. Rest of your income (except this income can be charged at normal rates)
- If your NRE account is with a non-Indian bank (e.g. Citibank, HSBC etc.), you cannot claim benefit of 20% concessional rate.
- The benefit of concessional tax rate can be taken ONLY till it is continued. If it is matured/broken, then this special tax benefit gets lost.
- In case amount in these deposits are high, you will have to pay advance tax otherwise you’ll have to bear interest u/s 234A,B,C of Income Tax Act.
- If you return back to India, you have the option to re-designate this account either as resident account or transfer a portion of funds to a Resident Foreign Currency (RFC) account.
- Bear in mind that NRE is a rupee account so your investments will carry currency risk, just in case you wish to repatriate & use it out of India later on.
- It is a myth that to open an NRE deposit, you have to open an NRE account also.
- At the time of transferring money to create an NRE deposit, currency conversion charges may apply.
#3: Foreign Currency Non Resident (FCNR):
- FCNR is a foreign currency denominated account where you can park your foreign earnings and it will be free from exchange rate fluctuations.
- You can create this FD only during the period that you are a non-resident.
- Interest earned from FCNR accounts is tax free under Section 10(15)(iv)(fa) of the Income Tax Act (as discussed above) till your residential status is Resident and Not Ordinarily Resident (RNOR). After your status becomes ROR, it is taxable as any other resident FD and the applicable TDS shall also apply.
- FCNR account with a co-operative bank or other banks not falling in Second Schedule of RBI Act will not qualify for tax exemption. You can check the Second Schedule here on RBI website Link
- On your return to India, FEMA allows you to continue the deposits to maturity.
- On maturity of FD, you can convert the FD to either a resident FD or a RFC FD.
- Money in FCNR account is denominated in your currency of choice (e.g. USD, GBP, EUR, SGD etc.) and is freely repatriable any time out of India.
- At the time of transferring money to create an FCNR deposit, currency conversion charges may apply.
#4: Resident Foreign Currency (RFC):
- After you return to India and when you become a resident as per FEMA, you can choose to park your overseas earnings or your NRE balances to an RFC account. You CANNOT open this account when your status is a non-resident as per FEMA.
- Interest earned from RFC account is exactly similar to FCNR account: it is tax free under Section 10(15)(iv)(fa) of the Income Tax Act (as discussed above) till your residential status is Resident and Not Ordinarily Resident (RNOR). After your status becomes ROR, it is taxable as any other resident FD & TDS is also applicable.
- Money in RFC account is denominated in your currency of choice (e.g. USD, GBP, EUR, SGD etc.) and is freely repatriable any time out of India.
- At the time of transferring money to create an RFC deposit, currency conversion charges may apply.
Some other points on Non Resident Accounts
- Re-designate all your accounts, deposits, investments from “non-resident” to “resident” within a reasonable time. What is “reasonable time” has not been defined under the Act – so understand this, if you are caught violating FEMA, reasonable time is what you are comfortable in convincing the enforcement authorities/judge – it is as simple as that
- Requirement to re-designate kick in from the day you become “resident. Ideally, and this is my interpretation considering a harmonious interpretation of various provisions of FEMA, you become a resident from the day you return to pick up employment or in any case, with an intention to stay for an uncertain period.
- Very Important point: Though interest on non-resident accounts is tax free in India, if you qualify as a tax resident in a foreign county (for e.g. USA), it will be taxed in that country. So please check the local tax laws and comply accordingly. If in doubt, engage a CPA. For USA based NRIs, this is especially important that India now as an IGA on FATCA with USA (read my post CRS & FATCA: Overview and Implications for USA based NRI Link). US NRI should also bear in mind to disclose these assets in mandatory reporting to FINCEN and IRS otherwise be ready for massive penalties – Read my posts on IRS Form 8938 Reporting by US NRI Link and IRS Foreign Bank Account Reporting (FBAR) by US NRI Link
- If you are an NRI and file a return, please show the exempt interest income from the accounts in the “exempt income” section in the return.
- If you are not planning to return to India, please note that though NRE fixed deposits offer a good tax free interest, the wealth will be subject to currency risk. Hence, it is advised to consider FCNR deposits as they are denominated in foreign currency only and does not impose any currency risk. Even if you return to India and do not have a long term plan of settling down here, you can shift the money to RFC account.
- As per FEMA rules, you can add a non-resident or a resident relative or a mandate holder in the non-resident accounts. This is much better than a simple nomination and should be considered.
- In your Indian will, ensure details of all these accounts are mentioned.
- Given the overreach of tax authorities, in case of a scrutiny assessment, you may be asked to provide source of funds for credit to these accounts and if the same is not properly explained, Assessing Officer can treat it as a “cash credit” u/s 69 of IT Act & levy tax on it. So, keep the gift deeds, overseas bank statements, overseas salary slips, W-2 forms (in case of a US based NRI) ready – it does not harm to be a bit over-prepared when it comes to tax, what do you say?
Hope the article was useful. For personalised tax advice, you can reach out to me on contact@abhinavgulechha.com