Tax Planning for NRIs Returning to India
By Tracie Sloop Frost
Editor’s Note: This article was first published on July 29, 2015 and has been updated to accommodate regulations.
The decision to return permanently to India is a serious matter for many Indians living abroad. Not only does this decision involve questions of familial and social benefits, health considerations, and nostalgia for home, it also requires careful financial planning and preparation. In this article, we examine some of the most common areas of financial planning for returning Non-Resident Indians (NRIs).
In general, investment and tax provisions relating to NRIs returning to live in India are fairly generous. However, NRIs should carefully plan their return to India to ensure there are no surprises with respect to managing their overseas income and investments.
The FEMA and the ITA
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). It is important that NRIs know their residency status with respect to both laws, and that they make important investment decisions with both statutes in mind.
The FEMA regulates foreign investment; transactions of Indian residents outside India are covered by FEMA. 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 who:
- Held an Indian passport at any time, or
- Was an Indian citizen, or whose parents or grandparents were Indian citizens, or
- Is a spouse of an Indian citizen.
An NRI permanently residing outside India is treated as an ‘ NRI under FEMA’ irrespective of the number of days of their stay in India. Residency under FEMA is defined by intent. 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. 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 as long as they spend fewer than 182 days during the tax year in India. Once an individual exceeds 182 days present in India, that individual becomes a resident for tax purposes either as:
- A resident but not ordinarily resident (RNOR) taxable only on Indian sourced income; or
- A resident and ordinarily resident (ROR) taxable on worldwide income.
A person who qualifies as a resident for any tax year can be treated as an RNOR if the following two conditions are met:
- The individual has been a non-resident in India for nine of the past ten tax years, and
- The individual has been in India for a total of 729 days or less during the seven tax years preceding the relevant tax year.
Treatment of Foreign Assets under FEMA
Under FEMA, a resident in India is free to hold, own, transfer or invest in assets situated outside India. However, those assets must have been acquired or owned when they were a resident outside India or inherited from a person who was resident outside India. Further, foreign asset transactions can be made even after an NRI returns to India for permanent settlement. There are a range of ways that NRIs can hold foreign earnings after permanently returning to India. However, most generally fall under two principle schemes:
Exchange Earners Foreign Currency (EEFC) Accounts
All resident foreign exchange earners can credit their foreign exchange earnings to an Exchange Earners Foreign Currency (EEFC) Account. Professional earnings – including directors fees, consultancy fees, lecture fees, and honorarium received by a professional, in addition to payments received by exporters and several other categories of income – can be credited to an EEFC account.
Funds held in EEFC accounts can be utilized for all permissible current account transactions and also for approved capital account transactions. 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 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
Residency for tax purposes is dependent on actual presence in India. When an NRI returns to India, they will eventually be taxed on global income. However, with careful planning, an NRI can prolong the time before they are designated resident and ordinarily resident (ROR) for tax purposes, and become liable for tax on worldwide income.
Because RNORs are accorded the same tax relief as NRIs, income from abroad is not taxed in India when an individual is resident but not ordinarily resident. In fact, depending on the date of return, an individual can take advantage of RNOR status for up to three tax years. However, individuals should bear in mind that they will still be liable for tax on their Indian sourced income as an RNOR.
Tax on Conversion to Resident Foreign Currency Accounts
When an NRI returns to India, any NRE/FCNR bank account must be re-designated to an RFC account. Interest on NRE and FCNR accounts is exempt in the hands of NRIs and RNORs. However, once the individual becomes an ROR after a period of two to three years of permanent residency in India, interest on the RFC accounts becomes taxable.
NRIs and RNORs are exempt from the wealth tax on assets located outside India. Once an NRI/RNOR’s status changes to ROR, the wealth tax can be levied on worldwide income.
However, 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 rules relating to import duties on household items for professionals returning to India. These transfer of residence rules provide for clearance-free duty of up to 75,000 Rupees (US$ 1,175) for household articles and personal effects when the individual has been on foreign assignment for 365 days during the preceding two years. Other rules apply for shorter assignments, while some restrictions also apply.
Careful Tax Planning 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.
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