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Key Takeaways
NRE FDs are an extremely popular investment tool among NRIs mainly due to their tax-free status. But not many know that the tax advantage may not last forever. Read on to know more:
Introduction
Non-resident Indians (NRIs) mostly rely on non-resident external (NRE) rupee accounts to park their foreign earnings in India. These accounts do not just let NRIs transfer a portion of their overseas income to their home country seamlessly, but also provide a great avenue of investment in the form of NRE fixed deposits (FDs).
NRE FDs are essentially fixed deposits opened by NRIs via their NRE accounts using their foreign earnings. NRE FDs are one of the most preferred investment options for NRIs as they fetch higher returns than regular savings deposits, with the principal and interest staying fully repatriable.
Is Interest on NRE account taxable?
As per the Indian tax laws, an NRI is liable to pay income tax in the country only on that income which has accrued or arisen in India.
Since an NRE account holds only that income that has been earned overseas and not in India; it remains completely tax-free.
This means that both the interest earned on an NRE FD and NRE savings account is not taxable as per the provisions of Section 10(4)(1) of the Income Tax Act 1961.
However, it must be noted that the primary eligibility criteria to maintain an NRE account and to earn tax-free interest income is that the person should qualify as an NRI in the first place under the Foreign Exchange Management Act (FEMA).
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Consideration of NRI as per FEMA
FEMA provides guidance on whether you can make a particular investment or not. For instance, you can open an NRE account only if you qualify as an NRI as per FEMA.
So, who is an NRI under FEMA? The Act uses the term ‘Person Residing Outside India’ to refer to an NRI. The definition for NRI is provided under Section 2 of FEMA.
FEMA says a person can be considered as ‘person resident outside India’ if his/her stay in India was for less than 183 days during the preceding financial year. However, there are certain exceptions to this rule.
Even if you stayed in India for less than 183 days during the preceding financial year, you might be considered a resident in India if your stay was for:
- Taking up employment in India,
- Undertaking any business activity or vocation in India, or
- Any other purpose indicating an intention to stay in India for an uncertain duration.
Therefore, NRIs permanently settled and residing outside India will continue to be treated as an NRI under FEMA irrespective of the number of days of their stay in India.
Also, it is important to note here that FEMA considers you an NRI from the first day of your departure if you go abroad for employment, business or vocation. The period of stay in India does not matter in this case. Accordingly, you become eligible for foreign investments and NRE/FCNR accounts as soon as you reach a foreign land.
So, if you left India on 15 April 2021, then you will be an NRI as per FEMA rules from 16 April 2021. Even if you are a student leaving India to study abroad, you are an NRI from Day 1 of your departure from India.
Similarly, people returning to India permanently are considered residents under FEMA from Day 1 of their return and should, therefore, get their NRI accounts (2) redesignated to resident accounts immediately.
When is NRE account interest taxable?
Since FEMA considers returning NRIs as resident Indians from the very first day of their return, maintaining an NRE account by such individuals is considered to be a violation.
NRE accounts are required to be designated as resident accounts or the funds held in these accounts should be transferred to Resident Foreign Currency (RFC) accounts immediately upon the return of NRIs to India for an uncertain period.
Once that’s done, you will enjoy tax-free interest income on these accounts only till you qualify as an RNOR (resident but not ordinarily resident). RNOR is an ‘automatic’ transitional status given to NRIs for up to 3 years(3) to help them shift assets from abroad to India without attracting huge taxes. As an RNOR, you will enjoy the same tax-breaks as an NRI.
But eventually, as soon as your residential status changes from RNOR to an ordinary resident of India, all your income (including your global earnings or interest income) will become taxable in India.
What are the exceptions in tax rules for NRIs?
In order to encourage NRIs to invest in their home country, certain types of income have been exempted from taxes. Here’s a list of all such tax-free earnings for NRIs:
- Interest earned on NRE and FCNR (foreign currency non-resident) accounts
- Interest earned on the government-issued notified bonds and savings certificates.
- Long-term capital gains of less than Rs 1 lakh from the listed equity-oriented mutual funds and equity shares (held for over 12 months).
- Tax on capital gains is exempted via Sections 54, 54F, and 54EC if such capital gain is reinvested.8
Availing tax exemption
An NRI is not required to file an income-tax return (ITR) in India if his/her Indian earnings comprises only the tax-free income mentioned above and TDS has been deducted on the same.
The obligation to furnish an ITR arises only in cases where the total income earned in India exceeds the maximum amount not chargeable to tax (currently Rs 2.5 lakh).
Filing an ITR is also important if NRIs want to avail certain tax deductions and exemptions from their total income, like deductions of up to Rs 1.5 lakh under Section 80c of the Income Tax Act. After taking into account the minimum exemption and tax deductions, the remaining Indian income is considered taxable for NRIs. Notably, the income tax rate for NRI in India is the same as that for a resident Indian (as per the prevailing income tax slab rates).
You can file your ITR by visiting the official website of the Income Tax Department of India at incometaxindiaefiling.gov.in and claim any tax refund if the TDS you have paid is higher than your actual tax liability.
Final note
Those planning to invest in NRE FDs should remember that the interest income earned on these accounts is tax-free only till the time an individual qualifies as an NRI; as soon as they return to India for an uncertain period of time, holding an NRE FD account is considered a violation of the law and it must be converted into a resident account.
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*Disclaimer: This article is published purely from an information perspective and it should not be deduced that the offering is available from DBS Bank India Limited or in partnership with any of its channel partners.
The purpose of this blog is not to provide advice but to provide information. Sound professional advice should be taken before making any investment decisions. The bank will not be responsible for any tax loss/other loss suffered by a person acting on the above.
