Recently, due to volatile rupee and favorable currency exchange rates, Banks have been aggressively marketing to NRIs for investments in the FCNR deposits with Forward cover highlighting a limited time opportunity comparing the yields with NRE Fixed Deposits. Banks have been selling the idea as an Arbitrage (Risk Free) opportunity between NRE and FCNR deposits with Forward contract.
On the other hand, as the rupee depreciates, RBI coming up various measures to attract foreign exchange that benefit NRIs and yield widens, there has been a lot of interest of NRI communities to invest in such investments. I have also received number of emails from NRIs asking about the taxability of these deposits. My friends working at various levels with different banks also have asked me to recommend NRIs to invest in one of these various schemes, viz. Ruppe Max by HDFC, Rupee Advantage Plan by Kotak, Rupee Plus Plan by ICICI, FCNB Premium Account by SBI, Premium Rupee Plan by Yes, Rupee Multiplier by IndusInd, etc. However, I believe that it may NOT be a good investment for MOST of the NRIs.
The chief reason for not recommending to NRIs is the taxability. In my first blog “Should NRI invest in FCNR deposits with Forward Cover”, while evaluating the investment, I briefly explained taxation as one of the issues. Banks have been marketing and have also mentioned on their website that the maturity proceeds are tax free. I have talked to relationship managers of a lot of banks and have asked for the specific provision of the Income Tax Act which allows them not to deduct TDS or which says such income is exempt. Unfortunately, I have not received any tax laws or any substantive reply from any bank, till date.
In this blog, I would go in detail of the provisions of Income Tax Act and my interpretation of the applicable laws.
Before we analyze the various provisions, it is important to note that the return on FCNR deposits with forward cover has two components – interest on FCNR deposit and return on forward contract. If you are of the opinion that it is not a return on forward contract but is a part of the FCNR interest or preferential conversion rate, your views can be different. I am not sure why would you think that with a signed forward contract, but if you do, your views about taxation could be different. Also, please note the views are personal and are shared for general benefit so that investors can make an informed decision and are not to be construed as an offer or advice. Please contact your financial or tax advisor or relationship manager before investing.
Taxation of interest on NRE Deposit Account:
Section 10 of the Income Tax Act lists the income not included in calculation of total income i.e. income exempt from Income Tax in India. As per Section 10 (4)
“(ii) in the case of an individual, any income by way of interest on moneys standing to his credit in a Non-Resident (External) Account in any bank in India in accordance with the Foreign Exchange Management Act, 1999 (42 of 1999), and the rules made thereunder…”
My view: Interest on NRE account is not included in total income and is exempt from Income Tax in India as per Section 10(4) (ii).
Taxation of interest on Foreign Currency (FCNR Deposit): As per Section 10 (15)
“(iv) interest payable—
(fa) by a scheduled bank to a non-resident or to a person who is not ordinarily resident within the meaning of sub-section (6) of section 6 on deposits in foreign currency where the acceptance of such deposits by the bank is approved by the Reserve Bank of India.”
My view: Interest on FCNR account is not included in total income and is exempt from Income Tax in India as per Section 10(15)(iv)(fa).
Taxation of Benefit due to Forward Cover:
On maturity, you would find out whether you made any gain or loss. So if you booked a forward contract to exchange money at Rs. 80/$, you would have made a gain or loss depending on whether the exchange rate is Rs. 70/$ or 85/$ respectively. If currency rate is Rs. 85/$, you would be better off not entering into forward contract. In an unlikely situation that conversion rate is Rs. 80/$, there is no gain but what is the point of entering into the forward contract? If forex rate is Rs. 70/$, the difference (gain) would be taxable in India as there is no exemption available for gain on forward contract to NRIs.
Section 195 relates to the TDS on payment (“Other Sums”) to NRIs. As per Section 195 (1), any person responsible for paying to a non-resident, any other sum chargeable under the provisions of this Act shall deduct income-tax thereon at the rates in force.
My view: The gain on forward contract is subject to income tax in India. Also, Banks are responsible u/s. 195 to deduct the tax on the gain.
My Communications with Banks:
Bank personnel have told me that FCNR and NRE accounts are exempt account. Also, money stays in FCNR deposits and then converted into NRE account and as both accounts are exempt and freely convertible account, there is no liability of income tax. They also mentioned that there will not be any TDS. I think even NRI clients are also told that bank will not deduct any TDS.
On sharing my logic about the taxation of such investment and that this could be mis-selling, the reply I got was mainly in the line of “Client (NRI) is responsible for his/her taxes. We do not provide any tax advice and we ask client to check with their tax advisors”. But my point is, when you compare the return or yield to the NRE FD interest or indicate online the maturity is tax free, you indirectly communicate to your client that it is completely tax free in India.
I sincerely doubt if banks are deliberately doing this as there could be severe consequences both regulatory (Income Tax) as well as business (loss of client’s trust) in long term. On the other hand, I am not sure if banks do not know the taxation (having big CA firms as consultants) and are ignoring this as I have not received any written communication about taxation of such investments from any bank till date. If one or two banks are doing it, it can be argued that it is an issue but all the banks are doing it. Furthermore, NRI relationship managers of any bank would tell me that it’s not his/her bank only but other banks are also doing it. And as, all are saying the same thing, taxation is not an issue.
As we are client-centric and have our clients’ best interest at heart, we mainly do not recommend investing in FCNR deposits with forward cover, due to the 5 reasons I mentioned in my earlier blog especially for NRIs from tax heaven countries such as UAE or Singapore. Taxation may not be an issue for NRIs from certain countries e.g. USA where NRE interest is also taxable. For you, I leave it to your fine judgment. Please be careful before you enter into an agreement.
I appreciate any feedback or comment regarding this post and your experiences or communications with your banks or advisors. If you found something new or relevant, please share so that I can update the blog for the educational benefit of the NRIs.