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.
Preamble:
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.
Summary
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.
Comments
sambhav
Can you please specify the income tax section under which the forward cover gain be taxable?
Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)
The most important point is whether it is an income or not (gift). If income, whether taxable or exempt. If it is not exempt, it is taxable. As per Section 56 (1) of the Income Tax Act “Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head “Income from other sources”, if it is not chargeable to income-tax under any of the heads specified in section 14, items A to E.”
Sandeep
Mr. Patel,
Read both your articles, very well written and very useful. Thank you.
I am considering significant investment into a Forward Linked FCNR deposit. I am offered an yield of about 15% I suppose due to the Forward premium. I note from your articles that taxation remains a grey area. Do you see any other risks?
I’d much appreciate your clarification on the applicability of the Forward Contract itself. As in your example, at 80+ per $ I am sure the bank wouldn’t have an issue honoring the Forward, but what if INR appreciates rapidly to <40 per $, will the bank still honor the Forward? Or is the Forward valid only as long as the INR remains above a preset threshold, say 50 per $?
Cheers.
Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)
I do not see any other risk for now. However, please consult your financial or tax advisor before making investments. You would have to check the contract whether there is any preset threshold. Usually there is none, but your written contract would be final. Please do not trust any words or promises of customer reps but read the contract.
Dinesh
Hi,
I just went on HDFC web site to check info the bank provides on Rupeemax.
According to their website, listed below, they don’t claim to provide tax exemption on the entire amount for RupeeMax.
It seems banks have taken note to Jigar Patel comment and made some correction.
http://www.hdfcbank.com/nri_banking/accounts/fcnr_deposits/foreign_currency_deposits.htm
However, I would like to hear Jigar’s view on the request from Sandeep Patel in the email chain above.
Thanks and keep up the great work.
Dinesh
Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)
Thank you and I really appreciate your kind words. But I can not take credit of what I didn’t do. HDFC already had “-” marked on taxation and I have mentioned it in my blog as well. The taxation comes into picture only when there is a gain i.e. spot exchange rate at maturity is lower than the forward rate and I think banks have not taken that into consideration. Thanks for your overwhelming comment.
Dennis
Hi Jigar,
See below answers to my questions from HDFC bank. Your thoughts? Thx.
Dennis
USA
Dear Sir,
1. How bank will define sell rate and forward buy rate? What is the formula to be used? – Sir, there is no formula to calculate the forward rate. It is the interest rate differential between two currencies and this is available at the inter bank levels.
2. Interest on FCNR account is not included in individual total income and is exempt from Income Tax in India as per Section 10(15)(iv)(fa). However, 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. Is that true? Do I get earnings documents for tax purpose every year from the bank? – Sir, As far as taxation is concerned there are no tax implications for you here in India, however on repatriation to your country depending upon the global taxation laws, the money you repatriate shall attract taxes for which you should consult your CA, who can give you accurate details. However, in India we shall not be deducting any taxes while your repatriate your maturity amount. Also there is deposit slip which you shall receive with the maturity details being mentioned on the same with maturity dates and amounts.
In comparisons, I don’t see tax cost to arrive at net earnings. Please do revert and advise. – Sir, when you make any investments from your NRE Account , there are no tax implications whatsoever that are deducted in India, only on repatriation depending upon the country you wire the money as per global taxation laws it shall attract taxes.
Thanks and good day.
Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)
1. Ok.
2. I have a different opinion as mentioned in the blog.
3. Effect of tax on net income – you have to judge yourself. I think it matters.
Thanks.
Rob
Hi,
I just filed for an FCNR deposit with Kotak bank with 12.5% interest rate for a tenure of 5 years. Being a US resident I am now worried how much will my earnings (principal and interest) will be subject to taxation since I will be filing joint taxes with my partner in the state of NY.
Please advice.
Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)
The interest on FCNR deposit will be taxable and you would have to show the same in your 1040. You may have to file Form 8938 and FBAR if the investment amount is above the reporting threshold. Please contact your CPA for taxation of forward contract. Thanks.
Dr Mohan Raj
Could you comment on the following banks response ?
I have read the blog which you have sent me.The interpretation of FCNR forward cover is wrong by this CA because of following reasons.
1. Normally forward cover is taken to hedge your position to save potential currency loss. The forward cover in India is taken by major exporters in India. There is no case of Income so no tax arises.
2. This blog mentioned about when you transfer funds from different currencies but all the banks are doing FCNR forward from funds which are already there in NRE account.
3. We have many clients who have done the forwards with us and their deposits have matured as well and we have not deducted any tax.
Plus sending you this email and confirming that there is no TDS on income arise on maturity of FCNR forward.
Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)
If the interest rate difference if more than 1%+, you may do it. Please note that the yield difference is a gimmick. The interest rate on NRE deposits are compounded quarterly. While the yield may be 11%, if the same is converted into quarterly compounded interest rate, it could be just 9.25%. You need to compare this rate with NRE FD rate and only if it is more than 1.5-2%+, I would recommend. The taxation of interest is debatable and of the bank says it is not taxable and no TDS deducted, you may take that risk. Thanks.
Dr Mohan Raj
Suppose the banks give written commitment that they will not take TDS then are we safe ? Funds are from UAE where there is no tax.
Jigar Patel, CFA (USA), MBA-Finance (USA), CPA (USA), CA (India)
Yes, provided you get about 1.5-2+% more than NRE. Thanks.
Dr Mohan Raj
Dear Mr. Jigar,
Thanks for your earlier inputs. One more clarification :
Kotak Bank in their web site for High Yield Currency Plan state :
1) Invest through your foreign currency funds or NRE deposit
2) Minimum NRE deposit amount is Rs. equivalent of USD 25,000/- or equivalent in any of the nine currencies for which we have a Nostro account
3) Interest earned are exempted form Income tax in India
4) Fully and freely repatriable deposit (both principal and Interest)
Just wanted to know if the bank has a NOSTRA account does it change the situation regarding possible taxation ?
Thanks