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Understanding Special Tax Provisions for NRIs
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Eligible incomes including investment income and long-term capital gains from foreign exchange assets
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Exemption from tax
The below content is purely for informational purposes and is not intended to constitute advisory of any kind. Please note, these are in-depth articles which are best viewed on large screen devices like laptops, desktops and tablets. The position reflected in this article has been updated as of October 31, 2024.
The Income Tax Act 1961, mandates Non-Resident Indians (NRIs) and Persons of Indian Origin (PIOs) to disclose income earned from their investments and transactions in India. This includes interest earned on deposits and bank accounts, dividends, etc. They also enjoy certain tax benefits on their income.
In this article, we take a broad look at how NRIs and PIOs can avail these tax exemptions.
Which sections of the IT Act provide special tax concessions to NRIs and PIOs?
The tax provisions under sections 115C to 115I of the IT Act are exclusively meant for NRIs and PIOs resident outside India. To know more about whether you qualify as an NRI or a PIO, please click here.
What incomes are eligible for the special tax provisions?
The concessionary tax provisions are applicable to two types of income:
- Investment Income earned from foreign exchange assets
- Long Term Capital Gains from the sale of such foreign exchange assets
Did you know?
The Double Taxation Avoidance Agreement (DTAA) between countries helps NRIs, PIOs and OCIs to avoid being taxed twice on the same income in both their home country and India.
What is a foreign exchange asset?
Assets bought using convertible foreign exchange, are classified as foreign exchange assets. These are:
- Shares in an Indian private or public limited Indian company
- Debentures issued by a public limited Indian company
- Deposits with a public limited Indian company
- Any security issued by the Central Government
- Any other security that the Central Government may specify by issuing a notification
Assets purchased using convertible foreign exchange imply that the above-mentioned assets must be acquired by converting foreign currency into Indian rupees. To illustrate, when you transfer dollars from your foreign bank account to your NRE account, these funds are initially converted into Indian rupees before being deposited into the NRE account. Consequently, if equity shares are bought utilising funds from the NRE account, they are considered as foreign exchange assets. However, if the same shares are acquired using domestic funds from the NRO account, they will not qualify for the preferential tax rate under the Special Tax Provisions.
What are the special tax rates?
According to Section 115E of the IT Act, 'Investment Income’ is taxed at 20% and 'Long Term Capital Gain’ is taxed at a 12.5%. These are flat rates and the basic exemption (below which income is not taxed) is not available.
Furthermore, your ‘Long Term Capital Gain’ is exempted from tax if you invest the net consideration within six months from the date of sale in another foreign exchange asset or a savings certificate (as per Sec. 10(4B), IT Act.). If the price of a new foreign exchange asset is lesser than the net sale consideration, the exemption would be computed proportionately, i.e.,
Exemption = (Long-Term Capital Gain/Net Sale Consideration) x Cost of the new foreign exchange asset.
It is important to note that there will be a three-year lock-in on the new foreign exchange asset purchased. If the new asset is transferred or sold within three years of purchase, then the exemption claimed earlier will be taxable in the year in which the new asset was transferred or sold.
Additional benefit under the IT Act
As per first proviso to Section 48 of the IT Act, capital gain from the sale of shares or debentures of Indian companies will be computed by converting the cost of acquisition, expenses incurred in connection with such sale (brokerage, etc.) and the sale price into the same foreign currency as was used in the purchase of these assets. The resulting capital gain in foreign currency will then be converted back into Indian currency. This method effectively gives the NRI/PIO the benefit of claiming exchange loss, if any, on all capital gains arising from the sale of shares or debentures of Indian companies, whether these are long-term or short-term
When is the special tax rate not applicable?
Under the IT Act, no deductions are permitted for:
- Expenses related to 'Investment Income'. For example, if you borrow money to invest in equity shares, then the interest paid on such borrowing will not be allowed as a deduction
- The benefit of cost indexation under the second proviso to Section 48 for long-term capital gains is not available
- Deductions under Sections 80C to 80U (e.g., ELSS, donations, etc.) are also not permitted
Did you know?
Basis section 80D and 80G of the IT Act, NRIs and PIOs are eligible for tax deductions on expenses such as medical expenses and donations to eligible charitable organisations respectively. For availing these exemptions, please mention your Permanent Account Number (PAN) in the online form for availing tax benefits.
Who is exempted from filing tax returns?
If your only income in India is being generated from ‘Investment Income’ or ‘Long Term Capital Gains’ from foreign exchange assets and the same has been subjected to the appropriate withholding tax (TDS), then you are not mandated to file an income tax return in India as per Chapter XIIA of the Act. If you have any other taxable income, then the same will be taken as a separate block and taxed as per the normal slab rates applicable under the general provisions of the IT Act.
What are the tax benefits for an NRIs becoming a Resident?
NRIs returning to India and transitioning into Resident status (RNOR) can continue being governed under these special provisions for their investment income (except interest, dividend income on shares in an Indian company) by furnishing a declaration of their intent to become a ‘Resident’ to the Assessing Officer, along with their Income Tax Return (ITR). The declaration option is available in the ITR form itself and one has to check the relevant box to continue availing of the benefit.
The ITR form serves as the official document through which taxpayers declare their income, deductions and other financial details to the tax authorities. By checking the relevant box indicating their intent to become a resident, NRIs transitioning to resident status can seamlessly continue availing themselves of the special tax provisions outlined for their investment income. Once the declaration to become a resident is made, NRIs can retain the benefit of the special provisions tax regime for their investment income every year until they transfer or convert their foreign exchange asset into money.
It is important to understand that the continuance of the special provisions regime for an erstwhile NRI/PIO who becomes a Resident is only available for the ‘Investment Income’ (except dividend income on shares in an Indian company) and not for the ‘Long Term Capital Gain’.
Option to Opt Out
According to Section 115I of the IT Act, one may choose not to be governed by the special provisions by declaring so in their ITR.
In such cases, all their income would be taxable according to the general provisions of the IT Act, 1961.
Income tax and laws are subject to change and involve several unique provisions. Therefore, it is recommended to consult a qualified tax advisor to know the applicability of these exemptions.
Conclusion
NRIs and PIOs have the option of being governed by specific tax provisions outlined in Sections 115C to 115I of the IT Act, pertaining to investment income and long-term capital gains from foreign exchange assets. Transitioning NRIs can maintain these benefits upon becoming residents by declaring their intent to the tax authorities. Understanding these provisions and seeking advice from a tax advisor is vital for NRIs and PIOs to manage their tax obligations effectively.
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Frequently Asked Questions
What types of income are eligible for the special tax provisions?
Investment income earned from foreign exchange assets and long-term capital gains from the sale of such assets are eligible.
What is considered a foreign exchange asset?
Assets bought using convertible foreign exchange, such as shares, debentures, deposits with Indian companies/banks, and securities specified by the Central Government, are considered foreign exchange assets.
What is the process for NRIs transitioning into resident status to continue availing of special tax provisions?
They must declare their intent to become a resident to the Assessing Officer along with their return of income by checking the relevant box in the Income Tax Return (ITR) form.
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The contents of this article/infographic are meant solely for informational purposes. The contents are generic in nature and are not intended to serve as a substitute for specific advice on any matter whatsoever. The information is subject to updation, completion and verification and the applicable norms may keep changing materially from time to time. This information is also not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to applicable laws or would subject ICICI Bank Limited/its affiliates to any licensing or registration requirements. ICICI Bank Limited/its affiliates and their representatives shall not be liable for any direct or indirect losses or liability incurred arising in connection with any decision taken by any person on the basis of this content. Please conduct your own due diligence and consult your financial advisor before making any decision. Terms and conditions of ICICI Bank and third parties apply. ICICI Bank is not responsible for third party services. Nothing contained herein shall constitute or be deemed to constitute an advice, invitation or solicitation to avail any products/services of third parties.
