Interest on NRE accounts is usually exempt from income tax
My daughter moved to the US in August 2016 to study. While here in India, she had bank fixed deposits and three mutual funds in her name. She gets a small amount for on-campus work for which taxes are deducted in US. Is it necessary to convert her savings and fixed deposits to NRO or NRE accounts? She has also taken an education loan from a nationalised bank and I am a co-applicant. The monthly interest is deducted from her bank account, in which I am the second holder. Can I (her father) claim tax benefit for the interest payment since I am a salaried employee and a co-applicant for the loan? Does she have to pay tax on the interest income from fixed deposits? Can she invest in mutual funds (to reduce fixed deposit exposure) in India, and if so, does the Foreign Account Tax Compliance Act (Fatca) declaration have to be changed?
The savings bank and fixed deposit accounts will need to be designated as Non-resident Ordinary (NRO) accounts as your daughter will qualify as a “person resident outside India” under the exchange control laws.
Under the income-tax law, tax deduction for interest repayment on education loan for higher studies is allowed to the individual if the repayment is from the taxable income of that individual. In your case, the interest on loan is deducted from your daughter’s savings bank account. In such a case, it may be considered that interest on education loan is repaid by your daughter and deduction for interest will be available to the person repaying the loan.
Based on the facts of your case, your daughter will most likely qualify as a non-resident of India for financial year 2017-18 under the income-tax law. As a non-resident, she will be taxable only on India-sourced income, that is, income earned in India and income received in India. Income earned outside India and received outside India will not be taxable in India.
Therefore, interest earned on the bank accounts in India is taxable in India. But there are certain exemptions under the Indian income-tax laws, such as:
a. Interest earned on Non-Resident (External) Rupee (NRE) Account (savings or fixed deposit) is exempt from tax for an individual who qualifies as a ‘person resident outside India’ under the exchange control law.
b. Interest earned on the deposit in Foreign Currency (Non-Resident) (FCNR) Account is exempt from tax for an individual who qualifies as a non-resident or not ordinarily resident in India under the India income-tax law.
c. Interest earned on Non-Resident Ordinary Rupee (NRO) account (savings or fixed) is fully taxable. A deduction up to Rs10,000 may be claimed for interest earned on savings account while filing the tax return. Interest is taxable at progressive rates, from 10% to 30% (plus surcharge, if applicable, and education cess). The maximum marginal rate is 35.535%.
Please note, determination of residential status is different under income-tax laws and exchange control laws. Your daughter will be required to file a tax return and pay taxes in India only if her gross total income exceeds Rs2.5 lakh.
Individuals who qualify as resident Indians, non-resident Indians and Persons of Indian Origin can invest in mutual funds. Dividend income from specified mutual funds is exempt from tax in India.
Units of equity-oriented mutual funds held for more than 12 months are considered as long-term capital asset. Long-term capital gains on sale of equity oriented mutual funds are exempt from tax in India. Short-term capital gains on the same are taxable at flat 15% (plus surcharge, if applicable, and education cess).
Units of non-equity (debt) oriented mutual funds which are held for more than 36 months are considered as long-term capital asset. Long-term capital gains on sale of debt mutual funds after giving benefit for indexation are taxable at a flat 20% (plus surcharge, if applicable, and education cess). Short-term capital gains on the same are taxable as per the slab rates as applicable.
Regarding Fatca, financial institutions in India are required to report details of financial investments made by US taxpayers in India to the US tax authorities, and vice versa.
Accordingly, your daughter may submit a self-declaration with respect to her residential status in the US and investments in India.
Sonu Iyer is tax partner and people advisory services leader, EY India.
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