Tax liability on interest received on NRE accounts for NRIs upon return

Individuals not residing in India maintain a Non-Resident External (NRE) bank account. An NRE account is an Indian-rupee denominated account. The account can be in the form of a savings, current, recurring, or fixed deposit account. Non-Resident Indians (NRIs) can repatriate their foreign earnings from abroad to NRE accounts. Similarly, NRIs can also transfer funds from an NRE account to a foreign account.

NRIs maintaining an NRE account is entitled to interest on the amount of balance standing in the account. The interest earned on the NRE account is exempt from tax provided:

1. The residential status of the individual continues to be NRI.
2. The individual has the permission of the Reserve Bank of India (RBI) to maintain the NRE account even after a change in the residential status to a resident.

Hence, the interest earned is not exempt from tax in all the cases. In a case where the individual becomes a resident in a particular year, the interest earned would not be exempt from tax. Also, if an individual NRI is returning to India, the individual has to convert their NRE account to a resident savings account or an RFC (Resident Foreign Currency) account. 

For example, an individual was residing outside India for the last 12 years and has returned to India under permanent employment in India. The individual has an NRE account on which he earns interest income and has been claiming an exemption under the income tax law. The individual does not close his NRE account. He will close the account in the subsequent financial year after his return to India. 

In the above case, would the interest income on the NRE account continue to be exempt from tax after his return to India? Here, the residence of the individual would be as per the Foreign Exchange Management Act, 1999 (FEMA).

As per the rules, interest earned on NRE accounts is exempt from tax for an individual who is ‘Person Resident Outside India (PROI)’ under FEMA. The interest is taxable for an individual who is a ‘Person Resident in India’ (PRI) under FEMA and who does not have the permission from the RBI to maintain an NRE account.

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Under FEMA, an individual is a PRI if he resides in India for more than 182 days during the preceding financial year. There are certain exceptions to the above rule. A PRI will not include an individual who comes or stays in India unless the individual:

1. Comes for or on taking up employment in India; or
2. Comes for carrying on a business or vocation in India; or
3. For any other purpose, as would indicate his intention to stay in India for an uncertain period.

Thus, an individual who has come to India for taking up employment or carrying on business in India would be a PRI. 

Thus, in the example mentioned above, the individual under permanent employment would be a PRI in India. Accordingly, interest earned on his NRE account would be taxable.

Also, in case the NRE account is a savings account, the interest earned by the PRI would be entitled to a deduction up to Rs 10,000 under section 80TTA of the income tax law. Further, in a case where the NRE is a senior citizen, the interest earned is entitled to a deduction under section 80TTB of the law. 

In a case, where an individual arrives in India in between a year, an exemption is available for interest income earned till the date of arrival in India. The residence under FEMA would be on a yearly basis.

If the individual is in India for more than 182 days during the preceding financial year, he will qualify as a resident. Consequently, for the year of arrival, the individual can claim the interest income as exempt in India. However, for the subsequent year, once the residence criteria for the preceding year are met, the interest income would be taxable.

For any clarifications/feedback on the topic, please contact the writer at sweta.dugar@cleartax.in