Featured Article - NRE / FCNR tax exemptions

PREAMBLE

NRI's have always played a pivotal role and contributed to the economic development of India and invariably supported the Government in times of economic crisis, be it the worst forex reserve crisis in 1992 when SBI's India Development Bonds were well subscribed by NRIs or year 1998 when NRIs contributed app. $ 4.5 bn. in SBI's Resurgent India Bonds or year 2000 when although USA NRIs were not eligible to participate, the NRIs elsewhere subscribed a mighty sum of app. $ 5.5 bn. in less than 3 weeks time in the issue of India Millennium Deposits. Even during the previous year, inspite of interest rates on NRE deposit being drastically reduced by RBI from average of 6.50% per annum to app. 2.25% per annum and Foreign currency deposit rates for a long time been at par with LIBOR, NRIs have added US$ 8.01 bn to the Forex reserves of the nation.
Since the inception of liberalisation process in 91-92 initiated by Hon'ble Prime Minister Dr. Manmohan Singh, the Government on its part, also has been appreciative of the role of NRIs and encouraged NRI investments in India, as reflected in various incentives offered to NRIs and policies initiated time and again as also reflected in Hon'ble Prime Minister's speech as the then Finance Minister while presenting the Union Budget for 1991-92 : " A comprehensive review of policies and procedures bearing on Non - Resident Indian investments shall be carried out and further relaxations made in order to remove all procedural difficulties and impediments to the setting up of industrial and other ventures by Non- Resident Indians."( Para 18 ).
Now, Finance Bill 2004-05, with effect from 1st September '04, proposes taxation in case of : (A) Non-Resident Indian's income being : .01 Interest income from NRE deposit [Sec.10(4)(ii)] .02 Interest income from FCNR deposit [Sec.10(4)(ii)r.t.w.Sec.10(15)(iv)(fa)] and (B) Returnee Non-Resident Indian's income being : .01 Interest income of continued FCNR deposit [Sec.10(15)(iv)(fa)] .02 Interest income of RFC accounts [Sec.10(15)(iv)(fa)]

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... MEMORANDUM & REQUEST TO RECONSIDER TAX PROPOSALS :

TAX EXEMPTIONS BE CONTINUED :

Interest earned by NRIs on NRE and FCNR deposits are granted tax exemptions since 1.4.1964 and all the investment schemes offered to NRIs thereafter, being NRNR deposits, State Bank of India's India Development Bonds, Resurgent India Bonds and India Millennium Deposits were all granted total tax exemption in India.
Said tax proposals originally mooted by Vijay Mathur's Committee in year 2002 were not implemented after thoughtful consideration of representations of NRIs across the globe.
In many countries including advanced countries like United Kingdom, non-residents per se are not taxed on their investment income. In USA too, in case of Non Resident, Non-Citizen's Interest Income, Long Term Capital Gains and Short Term Capital Gains are exempt from tax.
As a matter of fact, tax exemption is an incentive for NRIs in Middle -East and many other countries to maintain their deposits in India. As otherwise, now, the interest rates offered by banks in India being at par or less than the rates offered abroad the NRIs will not have any incentive / advantage of placing said deposits in India.

NRIs AT DISADVANTAGE OF LOWER INTEREST RATES :

Banks in India offer interest rates to residents in the range of 6% to 7% p.a. for 1 year term deposits.
Against this on account of Reserve Bank of India's directives , NRE rupee deposits are offered lower interest rate of 2.50% to 3.75% p.a. at par with LIBOR/SWAP whereas FCNR US$ deposits are offered interest of 2% to 3.40% p.a. for 1 to 3 years deposits.
As such, the NRE rupee interest rates do not cover average rate of inflation in the range of 5% and in effect NRE deposits erode capital invested by NRIs.
In view of this artificial cap on interest rates of NRE and FCNR deposits pegging the interest rates at a lower level and in disparity to interest rates offered to resident Indians, NRIs deposits should be allowed to be tax-free.

PROSPECTIVE TAX - A PRE-REQUISITE FOR EQUITY & JUSTICE :

If the Government thinks it proper not to continue the tax-exemptions and wishes to implement the tax proposals the same should be levied on deposits placed upon enactment of said tax provisions.
The NRE and FCNR deposits have been placed by NRIs on a crystal- clear assurance and understanding that the interest earned is exempt from tax in India and the principal and interest are fully repatriable.
Any unilateral and retrospective change in said terms and conditions is morally and legally incorrect and detrimental to the high standards of equity and justice promoted by Government of India.
An abrupt deletion of tax-exemptions will not only shake the confidence of NRIs at large but also be a major disincentive for future NRI investments in India.
Therefore all existing NRE and FCNR deposits should be granted tax exemption till maturity.
Tax exemption till maturity should also be granted on the grounds of continued tax-exemptions granted by the Government to NRIs on interest income arising out of existing investments in India Millennium Deposits and Non-Resident Non-Repatriable deposits ( NRNR ) till maturity.

TAX OF Rs. 610 Crs. ONLY :

As per Reserve Bank of India, NRI FC (BE & O) deposits as on 31.3.2004 amounted to Rs.1,35,422 crores, mainly comprising of Rupee and US$ deposits.
Presently Banks offer interest rates in average of 2.50% to 3.73% per annum on Rupee deposits and 2.00% to 3.30% per annum on US$ deposits.
Thus total payment of interest comes to app. Rs.4,065 crores at an av. interest rate of 3% per annum.
Double Tax Treaties ( DTAA ) with the countries, which account for more than 90% of NRI deposits attract withholding tax at 10% to 15% on interest payable to non-residents
Therefore Tax collection at higher rateof 15% amounts to Rs.610 crs. on interest estimated at Rs.4,065 crs.
Tax proposed from NRIs estimated at Rs.610 crores is not only a small amount vis-a-vis the principal amount of deposits placed by NRIs of say Rs.1,35,422 crores, but also comprises a very small portion of Direct tax collection totaling to Rs.1,39,365 crs. comprising of Rs.50,929 crs. of Income Tax and Rs.88,436 crs. of Corporate Tax proposed to be collected by the Union Budget 2004-05.
For a Central Revenue Plan, this amount of Rs. 610 crs. is indeed an insignificant contribution but the same has indeed a very large cost attached as at stake is " the trust and confidence reposed in India by NRIs across the globe ".

COMMON TAX RATE OF 10% :

If tax is levied, the same may be levied at a uniform tax rate of 10%.
The tax rate at 10% is suggested in view of existing DTAA with Indonesia, Oman, Portugal, South Africa and Qatar providing for withholding tax rate of 10% on interest income of NRIs residing in said countries. Whereas DTAA with UAE, which is major source of NRI Deposits, has withholding tax rate of 12.50%. And DTAA with USA, UK, Singapore, Canada, Australia, New Zealand provide for withholding tax at 15%.
As more than 55% of NRE/FCNR Deposits are originated from UAE, Oman and Quatar and almost 90% of total deposits originate from all these countries; Residents of said countries being covered by provisions of relevant DTAA are eligible for tax rate in the range of 10%, 12.50% or at the most 15%.
Therefore, a uniform tax rate of 10% should be made applicable to all the NRIs as regards interest earned from NRE and FCNR Deposits placed on or after the enactment of the said proposals.
Support for 10% tax rate is also found in the provisions of Section 115C(f)(iii) whereby a Deposit with an Indian Bank for 36 months or more being defined as a long term capital asset is subject to tax rate of 10%, vide Section 115E(b)(ii).
The view of fixed deposit being capital asset under Section 2(14) of the Income Tax Act 1961 and Section 2(e) of the Wealth Tax Act 1957 is also upheld by Calcutta High Court judgment of CIT V. East India Charitable Trust. [ (1994) 73 Taxmann 380) ].

PROVISIONS NECESSARY FOR NON FILING OF TAX RETURN :

A matter of grave concern is the applicability of various invisible provisions of Income Tax Act, 1961, arising out of said tax proposals whereby in all cases of NRIs having total income exceeding Rs.50,000, NRIs will be required to : ( i ) apply for Permanent Account Number (PAN) ; ( ii) avail TDS certificates from various banks ; ( iii) prepare annual accounts ; (iv ) appoint a Chartered Accountant or Tax Practitioner ( v ) file tax returns every year and (vi ) appear before Tax Authorities in India, if summoned.
For NRIs residing far away and visiting India not very often, compliance of all these requirements will be a Herculean task and will cause unwarranted difficulties.
Accordingly , if tax proposals are enacted, then , appropriate provisions be introduced granting exemptions to NRIs absolving them from requirements of filing tax return etc. , provided appropriate Tax Deduction at Source from interest on NRE and FCNR Deposits is made by concerned Bank.
Similar provisions already exist in Chapter XII-A of Income Tax Act 1961 inserted since 1.6.1983 providing simplified mechanism of tax collection and non-filing of tax return by NRIs as regards investment income and long term capital gains arising out of specified assets. Section 115G specifically exempts / absolves Non Resident Indians deriving income from specified assets from filing of tax returns if they do not have other taxable income in India.

SIMPLIFICATION OF PROCEDURAL ASPECTS :

An appropriate provision be inserted, providing for uniform tax rate on interest income from NRE and FCNR accounts,
relevant provision also be included in Chapter XVII-B for deduction of tax at source at appropriate rate,
exemptions from filing of tax return be incorporated , subject to deduction of appropriate tax,
said provisions may specifically include NRE and FCNR deposits with foreign banks and NRE deposits with Co-Operative banks also, as existing provisions of CH. XII-A donot include foreign and co-op banks,
appropriate provisions be incorprated for uniform tax rate of deduction as presently, Section 195 r.t.w. Para-1(b)(i)(A) of Para-II of the FIRST SCHEDULE provides for tax deduction at source @ 20% " on any investment income " and (ii) Para-1(b)(i)(G) provides for tax deduction at source @ 30% " on the whole of the other income ".

CONCLUSION :

It may be summarised that NRI depositors already have the option of - ( i ) being taxed at 10% to 15% taking recourse to provisions of relevant Article of Double Tax Treaty ( DTAA ) between India and their home country ; ( ii ) take recourse to tax of 20% treating the interest as investment income in case of deposit for 1 year or 2 years as per provisions of Section 115E(b)(i) ; or ( iii ) pay tax at 10% on long term capital gains arising out of cumulative option for 3 years deposit, as per provisions of Section 115E(b)(ii).
However this would require tremendous efforts by by each and every individual NRI.
Being acquainted overseas with minimum procedural requirements regarding tax matters as also till date non requirement of filing tax returns as regards their NRE and FCNR deposits in India , the procedural aspects and difficulties may discourage many of their existing and future investment plans in India.
As the Government's intentions have been " to remove all procedural difficulties and impediments for NRIs " , tax collection should coincide with simplicity and convenience to honest tax-payers.
With a view to follow said cardinal principles and not to discourage and dishearten NRIs from retaining their funds in India and thereby continuing their contribution to the growth of national economy, it is suggested that tax deduction / collection should be provided for in a simple and appropriate manner requiring the banks to deduct tax at source and ABSOLVE NRIs not having other income above the threshold exemption limit from the responsibility of filing tax returns in India and availing PAN etc.
This provisions are of great importance as it may be appreciated that NRIs have not given prime importance to monetary income over their emotional ties and economic development of their mother-land as evident from the fact of NRE and FCNR deposits increasing from Rs.1,10,021 crores in 2003 to Rs.1,35,422 crores in 2004 inspite NRE interest rates being reduced from 6.50% to 2.25% p.a. in a short span of last 12 months.

RETURNEE NRIs :

Presently NRIs returning to India for permanent settlement are exempt from income-tax as regards their global income and interest income of continued FCNR deposits and also Resident Foreign Currency ( RFC ) deposits so long as their residential status under the Income Tax Act,1961 is determined as ' Non-Resident ' ( NR ) or ' Resident but Not Ordinarily Resident (R but NOR).
Normally for NRIs returning after 8 to 9 years of stay abroad, said benefits are applicable for 2 to 3 years.
Now the Finance Bill 2004-05 proposes to tax interest from foreign currency deposits being continued FCNR deposits and RFC deposits by modifying Section10(15)(iv)(fa) whereby a unique paradox is created for a returning NRI being : (i ) granted exemption on interest income arising out of bank deposits held outside India which otherwise also offer better interest rates but (ii) liable to pay tax if such foreign currency accounts are maintained in India by way of continued FCNR deposit or as an RFC deposit.
This will simply discourage returning NRIs from repatriating funds to India and force them to retain the same abroad as permissible under FEMA,1999.
It cannot be the intention of the Statute to discourage repatriation of returnee NRI's funds into India and if so necessary amendments be made to continue tax exemptions provided by Section 10(15)(iv)(fa) , as per the existing law.

Best Wishes
RAJESH H DHRUVA
Chief Executive
nribanks.com
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Memorandum to Honourable Finance Minister to continue NRE / FCNR tax exemptions

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