Key Tax Planning and FEMA Compliance for NRIs Returning to India after a period of residence abroad

Key Tax Planning and FEMA Compliance for NRIs Returning to India after a period of residence abroad

Background

Returning to India after a period of residence abroad presents a unique set of financial considerations, particularly concerning tax planning and compliance with the Foreign Exchange Management Act (FEMA). Proactive and strategic planning is paramount to optimize tax liability, ensure regulatory adherence, and safeguard both global and Indian assets. This guide outlines key tax and FEMA aspects for Non-Resident Indians (NRIs) planning their repatriation.

I. Key Tax Aspects to Consider

The taxability of an individual in India is primarily determined by their residential status under the Income Tax Act, 1961. For returning NRIs, the “Resident but Not Ordinarily Resident” (RNOR) status often offers significant advantages during the initial years.

1.Residential Status Planning (Income Tax)

A Resident individual in India can be classified into:

• Resident and Ordinarily Resident (ROR): An individual becomes an ROR if they meet both of the following conditions:
  • Resident in India for at least 2 out of the 10 years preceding the relevant financial year.
  • Stayed in India for a total of 730 days or more in the 7 years preceding the relevant financial year.
  • Additionally, an individual who is a citizen of India or a Person of Indian Origin (PIO) having total income (other than foreign sources) exceeding ₹15 Lakhs and not liable to tax in any other country by reason of their domicile or residence, will also be deemed to be an ROR from FY 2020-21 onwards. This is a crucial amendment to prevent individuals from escaping tax residency in any country.
• Resident but Not Ordinarily Resident (RNOR): An individual qualifies as an RNOR if they meet the criteria for “Resident” but fail to satisfy either of the additional conditions for “Ordinarily Resident”. Specifically, an individual is RNOR if any of the following apply:

1.Non-resident in 9 out of the 10 years preceding the relevant financial year, OR

2. Present in India for less than 730 days over the past 7 years, OR

3. Indian citizen/PIO with Indian income exceeding ₹15 lakhs, present in India for 120-181 days during that financial year (this is a “deemed resident” provision).

The RNOR status is particularly beneficial as it shields global income (such as salary, pension, or rental income earned abroad) from Indian taxation. During the RNOR period, only income earned in India or foreign income received in India is subject to Indian tax. Furthermore, foreign assets are generally not required to be disclosed in the Indian Income Tax Return (ITR) while holding RNOR status. However, it is crucial to understand that once the individual becomes an ROR, disclosure of all foreign assets and income in Schedule FA and Schedule FSI of the ITR is mandatory. Non-disclosure can attract penalties under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

Tax Exemption Benefits for RNORs: Interest earned on Non-Resident External (NRE) and Foreign Currency Non-Resident (FCNR) accounts remains exempt from tax for individuals holding RNOR status.

Strategic Advantage of RNOR Status: The RNOR position offers a significant tax shield, especially for individuals returning from high-tax rate countries or countries with tax rates lower than India. It provides a valuable transition period to manage global assets without immediate Indian tax implications. It is vital to note that RNOR status is not automatic; careful calculation of days of stay and understanding the specific conditions are paramount.

2. Double Taxation Avoidance Agreements (DTAAs)

India has DTAAs with many countries to prevent residents from being taxed twice on the same income. Even during the RNOR period, or especially once you become an ROR, DTAAs can provide relief. If you have income taxable in both India and your country of prior residence, you may claim foreign tax credit in India using Form 67, provided the relevant DTAA applies and conditions are met. Form 67 must be filed on or before the due date of filing your Income Tax Return (or updated return, as applicable). Understanding the specific DTAA with your country of previous residence is vital.

3. Tax Planning of Foreign Investments like stocks , Immovable property etc.

During your RNOR period, consider strategically liquidating foreign assets that might become complex to manage or subject to higher taxation once you become an ROR. This could include foreign mutual funds, stocks, or real estate. The RNOR window offers an opportunity to realize capital gains from foreign assets without Indian tax implications, provided the proceeds are not remitted to India.

4. Tax Plan of Withdrawal of Retirement Amounts

It’s important to understand the tax implications of withdrawals from foreign retirement accounts in both the country of origin and India. Often, delaying withdrawals until you qualify as an RNOR or even an ROR (depending on the specific DTAA provisions related to pensions and retirement benefits) can help optimize tax outcomes

Illustrative Example

Scenario: Mr. Raj Malhotra, aged 40, has been residing in the USA for the last 10 years and plans to return to India on August 15, 2025. His assets in the USA include a 401(k) retirement account, a rental property, USD 150,000 in a US bank account, and US stocks worth USD 50,000, RSS from US Employer.

Analysis of Residential Status: For the Financial Year (FY) 2025-26 (April 2025 – March 2026), Mr. Raj Malhotra will be in India for approximately 230 days (from August 15, 2025, to March 31, 2026). While this makes him a “Resident” for FY 2025-26, he will qualify as a “Resident but Not Ordinarily Resident” (RNOR) because he has not stayed in India for 730 days or more in the preceding 7 years. He will likely retain RNOR status for FY 2025-26 and FY 2026-27.

Tax Impact during RNOR Period: As an RNOR, Mr. Raj Malhotra will be taxed only on his Indian-sourced income and any foreign income received in India. His global income, such as US salary, pension, or rental income earned abroad, will not be taxed in India during his RNOR period.

II. FEMA Planning – Key Aspects to Consider

The Foreign Exchange Management Act (FEMA) governs foreign exchange transactions and asset management for individuals in India. Compliance with FEMA regulations is critical to avoid penalties and ensure smooth financial operations.

1.Reclassification of Status (NRI to Resident)

Once you return to India with an intention to reside permanently and stay for more than 182 days in a financial year, your FEMA residential status changes from NRI to “Resident.” This change mandates the conversion of your Non-Resident External (NRE), Non-Resident Ordinary (NRO), and Foreign Currency Non-Resident (FCNR) accounts within a “reasonable time” (though “reasonable time” is not explicitly defined, it’s generally understood to be prompt, usually within a few weeks to months).

• NRE/FCNR accounts must be converted to Resident Foreign Currency (RFC) accounts.
• NRO accounts must be converted to Resident Rupee accounts.

2. Opening a Resident Foreign Currency (RFC) Account

Opening an RFC account is highly recommended for returning NRIs. It allows you to:

• Legally hold foreign currency in India.
• Repatriate funds freely from the RFC account if you decide to move abroad again.
• Earn interest on these funds, which is tax-exempt in India while you retain RNOR status.
• Transfer balances from existing NRE/FCNR accounts.
• It is crucial to note that RFC accounts can be held jointly with resident relatives on a ‘former or survivor’ basis, but the resident joint holder cannot operate the account during the lifetime of the primary resident account holder.

3. Informing Financial Institutions and KYC Updates

It is crucial to promptly inform your banks, brokers, and mutual fund companies about your change in residency status. This ensures compliance with regulations like FATCA (Foreign Account Tax Compliance Act) and CRS (Common Reporting Standard) and helps avoid potential penalties. You will also need to update your KYC (Know Your Customer) details, including your Permanent Account Number (PAN) and Aadhaar, with all financial institutions.

4. Managing New Foreign Earnings

Once your FEMA status changes to “Resident,” you must cease using NRE/NRO accounts for fresh foreign earnings. Any new income earned abroad must be routed through your resident accounts or RFC account. Using these accounts for new foreign income post-repatriation constitutes FEMA non-compliance.

5. Gifts/Inheritance Received from Abroad

Gifts or inheritances received by a resident Indian from relatives abroad are generally not taxed in India under Section 56(2) of the Income Tax Act, provided the donor is a “relative” as defined by the Act. However, it is essential to ensure proper documentation (e.g., gift deed) and adherence to FEMA guidelines for such transfers. It is important to ascertain the source and nature of these funds to avoid any scrutiny.

6. Foreign Investments as a Resident

• Pre-Return Flexibility: Before returning to India and changing your FEMA status, there are generally no FEMA restrictions on giving gifts of foreign currency (e.g., USD 50,000 to parents in India) from your overseas accounts.
• Post-Return Restrictions (Liberalized Remittance Scheme – LRS): After becoming a Resident, your ability to invest abroad comes under the Liberalized Remittance Scheme (LRS). The current LRS limit is USD 250,000 per financial year per individual for various current and capital account transactions, including overseas investments. This means you cannot continue to invest freely in foreign equities or assets as you did as an NRI unless routed through the LRS framework, which involves specific procedural compliances and tax collected at source (TCS) on remittances above certain thresholds (e.g., ₹10 lakhs for most purposes from April 1, 2025).

Example for Mr. Raj Malhotra (FEMA Application): Mr. Raj Malhotra can transfer his USD 150,000 savings from his US bank account to an RFC account upon his return. Funds in the RFC account are freely repatriable. The interest earned on the RFC account will be tax-free for him during his RNOR period. If Raj wanted to gift USD 50,000 to his parents in India, doing so before his return would have provided maximum flexibility without LRS restrictions. Post-return, any new foreign investments would be subject to LRS limits and TCS provisions.

Conclusion: Repatriating to India is a significant event that requires meticulous financial planning. By proactively addressing tax implications, adhering to FEMA regulations, and managing their global and Indian asset portfolios strategically, returning NRIs can ensure a smooth transition and secure their financial future in India.

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Disclaimer:

The views expressed in this article are the personal views of the author. Neither the views nor the analysis constitute a legal opinion and are not intended to be advice

Thank you

Ca Pawan Kumar