Fixed Deposits and Income Tax: A Must-Read for NRIs

What is Fixed Deposit?

Fixed deposits are low-risk investments that offer guaranteed returns, making them one of the safest forms of investment instruments, especially in India, where NRIs look for secure long-term investments rather than high-risk investments. 

Fixed deposits offer guaranteed returns through their locked-in interest for their entire tenure, providing individuals a sense of financial security and certainty in their financial planning. Unlike residents, fixed deposit investments for NRIs have to be maintained effectively for income tax returns. 

Types of Fixed Deposits for NRIs

• Non-Resident External (NRE) Fixed Deposits 

An NRE Fixed Deposit account is a tax-free account in India specially designed for NRIs. It allows NRIs to invest their foreign income in fixed deposits in India. Both the principal and interest amounts in this account are freely repatriable outside India without any restrictions. 

• Non-Resident Ordinary (NRO) Fixed Deposits

An NRO Fixed Deposits account is also designed for NRIs to invest their income earned in India. They can deposit income from rent, dividends, or pensions in India and earn interest on it. However, interest earned on Fixed Deposit accounts is subject to tax under the applicable tax rates. 

• Foreign Currency Non-Resident (FCNR) Fixed Deposits

Foreign Currency Non-Resident (FCNR) is similar to Non-Resident External (NRE) Fixed Deposit accounts. A Foreign Currency Non-Resident account allows you to hold designated foreign currency earnings in India and earn interest for a fixed period in foreign-denominated currency. The principal amount and interest earned can be freely repatriated back in foreign currency. 

Impact of Changing Residential Status on Fixed Deposits

All NRIs must be aware of the impact of applicable taxes on their Fixed Deposit Accounts once their residential status is changed to “Resident”. Exemptions for NRE accounts are only available when you are a Non-Resident under the “Foreign Exchange Management Act, 1999” (FEMA). The moment your residential status changes to a resident under FEMA, you will lose the tax benefits on your earnings in NRE accounts in India. 

Unlike the Income Tax Act, the intention of the stay (in India or abroad) is more relevant than the duration of the stay for determining the residential status of a person under FEMA. Moreover, it is legally required for every NRE account to be redesignated as a Resident Rupee Account immediately upon returning the account holder to India for taking up employment or for carrying out business or for any other purpose with the intention of staying in India for an uncertain period. 

For example, if an NRI decides to come back to India permanently, his/her residential status must be changed immediately to a Resident from the date of his return to India, and thereafter, the interest earned on his/her NRE deposits becomes taxable. 

Therefore, NRIs returning back to India must inform their bankers about their residential status shifts and redesignate their bank accounts and deposits accordingly. Additionally, you must adhere to the tax obligations and carry out proper tax planning with the help of your chartered accountant to manage your taxes.

Monitoring of Fixed Deposits by the Income Tax Department 

It is crucial for NRIs to re-designate their residential status as they move to India because the details of all Fixed Deposit related transactions are collected by the Income Tax Department. This is applied to every newly opened, renewed, or existing NRE, NRO, or FCNR deposit. This monitoring procedure is following the shift in the government’s focus to examine whether the expenditures and investments of the individuals are aligned with the income declared for tax purposes. 

Moreover, NRIs should also maintain the records of the source of income and residential status at the time of investment. Because in some cases, NRIs have received notices for investments made ten years ago. Having these documents will help safeguard against queries from the Tax Department and prove your source of income and residential status to counter these notices and prevent any penalty. It will also be beneficial for NRIs to file their tax returns in india.

Conclusion

Income tax on NRIs’ fixed deposit accounts is relevant to NRIs’ residency status. NRIs can reap the tax benefits from NRE and FCNR Fixed Deposit accounts if their residential status is NRI. As their residential status changes, they need to inform their bankers and redesignate them as Resident Rupee Accounts immediately under the FEMA Act of 1999. 

Furthermore, NRIs are required to maintain their Fixed Deposits transactions details to prove their source of income and residential status in the future if a notice arises. The tax department also gathers all these documents to ensure that expenditures and investments are aligned with the declared tax purposes. 

While fixed deposits offer a reliable way to grow your savings through guaranteed interest, it is crucial to become mindful of the tax implications that come with changing your residential status. Becoming aware of these tax implications can help you maximize their benefits. 

FAQs

Is NRI Fixed Deposit Tax-Free?

Not all fixed deposits held by NRIs are tax-free. The tax treatment depends on the type of deposit. For instance, NRE (Non-Resident External) FDs are tax-free in India—both the interest earned and the principal are fully exempt from Indian income tax. However, NRO (Non-Resident Ordinary) FDs are taxable in India, and the interest is subject to TDS at applicable rates.

NRIs should choose the fixed deposit type that best aligns with their residency status, repatriation needs, and tax profile.

What happens to FD when you become an NRI?

As per FEMA (Foreign Exchange Management Act) guidelines, once your residency status changes to NRI, you are required to inform your bank and convert your existing resident fixed deposits into NRO deposits.

Failing to do so can be considered a violation of FEMA regulations and may attract penalties.

Which account is tax-free for NRI?

Interest earned on NRE (Non-Resident External) and FCNR (Foreign Currency Non-Resident) accounts is tax-free in India. In contrast, interest earned on NRO (Non-Resident Ordinary) accounts is fully taxable and subject to TDS as per applicable income tax rates. 

How to avoid TDS on NRO Fixed Deposit?

While TDS (Tax Deducted at Source) on interest from NRO Fixed Deposits is mandatory under Indian tax laws, you can reduce the TDS rate by availing benefits under the Double Taxation Avoidance Agreement (DTAA) between India and your country of residence or obtain a Lower Deduction Certificate (LDC) for that particular financial year.