Tax Planning for NRIs Returning to India
In general, investment and tax provisions relating to non-resident Indians (NRIs) returning to live in India are fairly generous. However, NRIs must carefully plan their return to India to ensure there are no surprises with respect to managing their overseas income and investments.
In this article, we examine some of the most common areas of financial planning for returning NRIs.
NRI tax residency status under FEMA and ITA
To identify whether the income earned abroad will be taxed in India, NRIs must first consider their residential status for the financial year and whether the income was earned in India.
As per the Indian law, there are two applicable statutes governing taxation and foreign investment for returning NRIs – the Foreign Exchange Management Act (FEMA) and the Income Tax Act (ITA).
The FEMA regulates foreign investment and transactions of Indian residents outside India. This includes foreign bank accounts and foreign investments in real estate, equity, mutual funds, businesses, money transfers, remittances, borrowing and lending as well as gifts, among others.
The ITA, on the other hand, regulates taxation and defines the appropriate tax treatment of such investments.
Under FEMA, an NRI is a person who is a resident outside India who is either a citizen of India or a person of Indian origin. A Person of Indian Origin (PIO) is anyone who is a citizen of a country, other than Pakistan and Bangladesh, and:
- Has held an Indian passport at any time in their life;
- Was an Indian citizen, or whose parents or grandparents were Indian citizens; or
- Is a spouse of an Indian citizen.
Residency under FEMA is defined by intent. An NRI permanently residing outside India is treated as an ‘NRI under FEMA’ irrespective of the number of days of their stay in India. Once an NRI returns to India with the intent to settle permanently, that individual becomes a resident Indian for FEMA purposes. This is very different from the residency test for tax purposes – which is given under the ITA.
The ITA uses a ‘days present’ residency test to determine tax residency, regardless of intent. Under the ITA, an individual is an NRI for tax purposes if he or she meets the following conditions:
- Spends 182 days or more in the financial year (FY) in India; or
- Spends 60 days or more in the FY and 365 days or more in the four consecutive FYs preceding the relevant FY.
Once an individual meets these conditions, the person becomes a resident for tax purposes either as:
- A resident and ordinarily resident (ROR) taxable on worldwide income; or
- A resident but not ordinarily resident (RNOR) taxable only on Indian sourced income.
A person is treated as ROR during the year if he or she satisfies both the following conditions –
- Is a resident in India for at least two of the ten FYs immediately preceding the relevant FY; and
- Stays in India for a total of 730 days or more during the seven FYs preceding the relevant FY.
Resident individuals who do not meet the above conditions or meet only one of the conditions are treated as RNOR.
Treatment of foreign assets under FEMA
Under FEMA, an NRI returning to India is free to hold, own, transfer or invest in assets situated outside India. However, the provision is only applicable if the asset was acquired when the individual was resident outside India or was inherited from a person resident outside India.
The NRIs can hold foreign earnings and make foreign asset transactions through the following accounts:
Exchange Earners Foreign Currency Accounts
Exchange Earners Foreign Currency Account is a facility that resident Indians can use to credit 100 percent of their foreign exchange earnings to the account. The earning may include professional income – including director’s fees, consultancy fees, lecture fees, and honorarium received by a professional, in addition to payments received by exporters, and several other categories of income.
The facility helps account holders to minimize transaction costs as they do not have to convert foreign exchange into rupees and vice-versa. Furthermore, residents can use the funds held in EEFC account for all permissible current account transactions as well as for approved capital account transactions.
Account holders, however, must note that the amount withdrawn in rupees is not eligible for conversion into foreign currency and for re-credit to the account.
The account is maintained in the form of a non-interest bearing current account.
Resident Foreign Currency (RFC) Accounts
Indian residents may maintain a Resident Foreign Currency (RFC) account for foreign currency assets, which were held outside India at the time of their return. Foreign exchange amounts received as pension or benefits from employers outside India, gifts, or proceeds of life insurance policies in foreign currency may also be credited to this account.
RFC accounts can be maintained in the form of current or savings or term deposit accounts. The funds in RFC accounts are free from all restrictions regarding utilization of foreign currency balances, including any restriction on investment outside India. Residents can use their RFC accounts to reinvest sale proceeds of overseas assets.
Treatment of Indian assets held during non-residency
During the period that an individual is an NRI, they may hold assets, investments, and bank accounts in India. Special accounts exist for NRIs who hold investments in India.
Generally, an Indian bank account held by an NRI would be either a Foreign Currency Non-Resident (FCNR) account or a Non-Resident External Rupee (NRE) account.
These accounts are opened for the purpose of depositing income earned overseas. The funds held in these accounts can be remitted back overseas freely, subject to the terms and conditions of the resident country. Upon re-establishment of residency, an NRI must re-designate Indian banking accounts from FCNR/NRE to the RFC accounts mentioned above.
Similarly, returning NRIs must inform companies in which they have shares of their change in residency status, as well as firms in which they may own partnership interests.
Treatment of foreign assets under the ITA
NRIs returning to India can save tax on their global income for up to three FYs by taking advantage of their RNOR status; however, they are still liable for tax on their Indian sourced income as an RNOR.
Tax on conversion to Resident Foreign Currency Accounts
When NRIs return to India, they must re-designate their NRE/FCNR bank account to an RFC account. Interest on NRE and FCNR accounts is exempt in the hands of NRIs and RNORs.
However, once the individual becomes a ROR, interest on the RFC accounts becomes taxable.
Money and assets brought into India by an NRI who was ordinarily residing in a foreign country, and who has returned to India with the intention of permanently residing, is generally exempt for wealth tax purposes for a period of seven successive assessment years, although certain restrictions apply.
In addition, amounts held in an NRE account on the date of an individual’s return to India are deemed to be amounts brought into India on that date – they are also exempt from the wealth tax.
The wealth tax exemption does not extend to tax on income earned from assets brought into India.
Taxation on pensions
NRIs receiving pensions from former employers after returning to India may be liable for tax on that pension in India. This is subject to provisions of any double taxation avoidance agreement between India and the country from which the pension is received.
Another area not to be overlooked by NRIs returning to India is customs duties on the importation of goods following overseas assignments.
The Customs Act provides ‘transfer of residency’ rules relating to import duties on household items for professionals returning to India. These rules allow the import of personal and household articles, free of duty and certain other listed items, on payment of concessional rate of duty.
For those returning after a long stay abroad – one year or more than two years, the rules provide a clearance-free duty of up to Rs 200,000 (US$2,753) in household items. Other rules apply for shorter durations, while some restrictions also apply.
Careful tax planning for NRIs advised
NRIs returning to India for permanent settlement have many issues to consider. Careful investment and tax planning can help ease the transition and will allow individuals to avail themselves of the many tax breaks accorded to returning NRIs.