Today I will be writing about a very pertinent question that is in the mind of 99% of NRIs who return to India after staying away for a long time. From my professional work experience I can say that mostly the investment portfolio of these NRIs (especially those returning from Middle East) is heavily tilted towards NRE FDs.
While the obvious reason for this is that the interest income from FDs are tax free in India, the other aspect (and in all frankness I will say) is that the person does not apply enough thought to his financial planning – because if he had done that, he would have invested in equity mutual funds for long term financial goals which could have given much better return as compared to NRE FD which gives near zero “real” return to the investor.
Nevertheless, in this post, the focus is to understand what to do with these NRE FDs on return to India. While the course of action is unique in every person’s individual financial situation and goals, I am presenting some scenarios and general pointers that can prove to be a starting point for your decisioning on your NRE FDs on return to India.
Before we proceed:
NRE FD becomes taxable from the day you return to India. I have previously written a detailed post on NRE FD tax implications on return to India here: NRO, NRE, FCNR, RFC: Tax and FEMA Implications for Returning NRI
Also, I have written a detailed post on why NRI should not go overboard on NRE FD: NRIs: Do not go overboard on NRE FDs
I suggest that for better clarity, you read those posts firsts and then come to this post.
Image Credit: www.eaglerelocations.com
Scenario # 1: NRI returning permanently to India with no intention of going back and no long term non-INR denominated goals
This is the first scenario where person returns back to India after say 10 years of work abroad and wants to settle down permanently. He also does not have any financial goal which requires a commitment in non-INR currency.
In such a case, first thing to understand is that given the fact that person becomes resident as per FEMA on return, the tax free status of these FDs will not continue. The person has to update the residential status in these FDs and though bank will allow you to continue these FDs till maturity and even not impose TDS (which is generally applicable @ 10% in case interest paid in a financial year > INR 10,000), it is your responsibility to calculate proportionate tax and pay it to the Government.
Also read: NRI Definition: FEMA Act VS Income Tax Act
Effectively, NRE FD which was a super tax efficient investment till the time you were non-resident suddenly becomes a tax –inefficient investment. Interest income is taxed every year regardless of it being a cumulative FD. Most likely, even if you claim a 20% preferred tax rate on income from such FDs, effective post tax return for a 7% FD will be just 5.6% – and if we take a very conservative assumption of inflation to be at 6%, the real return will be almost zero.
Also read: How REAL are your investment returns?
In such a situation, my recommendation will be to tag this investment to a financial goal. This will give you a lot of clarity on whether it is a short term goal (money needed within next 10 years) or a long term goal. (also read this very good article by Dhirendra Kumar – link)
If the goal is short term, the plan of action can be as follows:
- If goal is due in next 3 years/part of emergency fund: Let it remain as a resident FD. No problem. Do not forget that if your tax slab is 30%, don’t forget to pay tax on interest income from these FDs at a concessional 20% rate by filling the tax return properly.
- If goal is more than 3 years away: In such a case, I will request you to explore debt mutual funds which are far more tax efficient than FD – within the debt fund category, you can look at liquid funds or gilt funds with a very low average maturity. The benefit of debt funds over FD is primarily from the taxation standpoint. Where FD is taxed every year as per your tax slab, debt funds are taxed only when you redeem the investment so this helps in deferral of tax liability. Also, if you redeem after 3 years, the gain qualifies as a “long term capital gain” and is taxed at a reduced 20% rate (along with indexation benefit) which reduces tax liability. Further, if such capital gain is very high, you can also claim exemption u/s 54EC (investing in specified bonds etc.)
If the goal is long term (i.e. > 10 years away), I would seriously request you to check the asset class level mix for this goal – for example, if 80% of assets tagged to the goal is FD, then understand that you’re seriously restricting yourself of the opportunity to create long term wealth. In such situations, you can have a equity: debt ratio of say 60:40 – So, after moving money to equity (preferably via diversified equity mutual funds), as regards 40% portion, I would again request you to consider debt funds as mentioned above.
Special point for US citizens/GC holders returning to India: USC/GC holders are well aware that these FDs were anyways not tax free to them even before returning to India, as US taxes its citizens and lawful permanent residents on global income (Also read: Taxation of US persons: An Overview). Now, after return to India, there may be issues for such persons in buying debt MF in India which is primarily because of SEC requirement of having a license before solicitation of investments from US persons and associated FATCA compliances. Very few AMCs hence offer investments to USC. However, bigger concern is that investment in mutual fund type investments in foreign jurisdictions are considered as Passive Foreign Investment Company (PFIC) by IRS and may require extensive reporting requirement –I am not an expert on this issue, please consult a CPA. Broader point I am trying to make is, USC/GC holder should carefully consider PFIC reporting implications prior to investing in Indian MF.
Scenario # 2: NRI returning with an intention of going back and/or has some long term non-INR denominated goals
I have always said that to protect yourself from currency risk, you should align currency of your investments with the currency of your financial goal – read my detailed post on this here: How NRI/PIO families can manage exchange rate risk in their investments
Hence, if you wish to return back in the long term, or need funds for a financial goal which will materialize in non-INR currency (for e.g. your daughter’s higher education in USA), then please note that apart from re-designating NRE FD as resident FD on return to India, you also have an option to convert the NRE FD into a Resident Foreign Currency (RFC) FD which is denominated in foreign currency.
Interest from RFC FD is not taxable in India, till your residential status as per Income Tax Act is that of “Resident and Not Ordinary Resident” (RNOR). I have already discussed tax implications of RFC in this post: NRO, NRE, FCNR, RFC: Tax and FEMA Implications for Returning NRI
Another benefit of RFC is that from a FEMA perspective, while a resident presently can send USD 2,50,000 per financial year outside India under RBI’s Liberalised Remittance Scheme (LRS), money standing to the credit of RFC does not fall within this limit and is free from all restrictions as regards repatriation outside India.
In this regard, my advice will be to calculate portion of NRE FD to be tagged to an INR goal (like retirement in India or buying a flat in India) and how much needs to be earmarked towards non-INR financial goals. Once you have the clarity, you can proceed as follows:
- INR goals: As explained in Scenario # 1
- Non-INR goals: Convert NRE FD to a RFC FD
Scenario # 3: NRI returning for a short (2-3 year assignment) to India – does not have intention to permanently settle down in India
For NRI returning back to India for a short employment stint, he becomes a resident as per FEMA and the NRE FD becomes taxable. Here, barring the money requirement over the 2-3 year period or specific goal like purchasing a flat, the requirement will most certainly arise in USD or any other foreign currency. My suggestion to such NRI is that similar to scenario # 2, identify the currency of the financial goal and take action basis that as follows:
- INR goals: As explained in Scenario # 1
- Non-INR goals: Convert NRE FD to a RFC FD
Hope the post has been of service to you. Please share your thoughts/feedback.