Interest on NRI deposits to remain tax-free

Fluctuation in foreign exchange reserves spurs move, banking sector seen benefiting.

Interest on deposits from non-resident Indians (NRIs) will continue to enjoy tax exemption.

Finance minister P Chidambaram has accepted the popular demand and said that the government would continue to exempt NRI deposits from tax.

The Finance Act of 2004 had proposed to withdraw tax exemptions granted to non-resident external (NRE) deposits from April 1, 2005. This would have meant that interest accrued up to March 31, 2005, but paid on or after April 1, would have come under the tax net.

"Not taxing NRI deposits will have a positive impact on the sector," said G V Nageshwar Rao, MD, IDBI Bank.

In the early 1990s, when the country was experiencing a balance of payment crisis, NRI deposits were given tax benefits for attracting foreign exchange. Many NRIs found it attractive to invest in India considering the higher rates of interest as compared to other countries.

The government's review of the tax is understood to have been prompted by fluctuations in foreign exchange inflows, the growing import payments and pressure on banks to hike domestic deposit rates in order to meet the growing credit demand.

The Reserve Bank of India's (RBI) decision to cap and reduce the rate of interest on NRI deposits till it was brought at par with Libor (London inter-bank offered rate) rates has seen a net outflow of NRI deposits.

Banks have for some time not been able to attract as much NRE deposits since the RBI capped interest rate on foreign currency non-resident deposits (FCNR(B)) at 25 basis points below the Libor. An internal RBI group had recommended that interest income from NRI deposits be taxed in line with domestic deposits.

This followed the Indian central bank's concern on growing foreign exchange inflows, and the fact that NRI deposits had grown considerably, thereby no longer meriting the need for any further tax benefits.

Moreover, had the government decided to impose tax on these deposits, the tax deducted at source anomaly between Indian and foreign banks, would have made it more attractive for NRIs to keep deposits with Indian banks, which would have been required to deduct a TDS at 22.44 per cent.

"NRI deposits are no longer attractive for expatriates since many overseas countries offer better structured and more attractive pricing," said a senior executive of a foreign bank.