NRE Account Tax: Is Interest Income Taxable?

A Non-Resident External (NRE) account is a financial tool for Non-Resident Indians (NRIs) to manage their earnings from outside India. It is a rupee-denominated account where funds are held in Indian Rupees, but deposits must originate from foreign currency. This account provides a way for NRIs to transfer and park their foreign income in India for use within the country or to be transferred back abroad.

Tax Treatment of NRE Accounts in India

Indian tax regulations provide specific advantages for NRE accounts held by individuals who qualify as a person resident outside India under the Foreign Exchange Management Act (FEMA). Under Section 10(4) of the Income Tax Act, any interest earned on the balance in an NRE account is completely exempt from Indian income tax. This exemption applies to both savings accounts and fixed deposits.

This favorable tax treatment extends beyond just the interest. The principal amount deposited into the account, which represents the individual’s foreign earnings, is not subject to Indian income tax. Consequently, the entire balance held within the NRE account is not considered part of the individual’s taxable income in India.

Furthermore, both the principal amount and the tax-free interest earned are fully and freely repatriable. This means an NRI can transfer the entire balance of their NRE account to a foreign country at any time without facing any Indian tax liability or requiring special permissions.

When considering gifts from an NRE account, transfers to individuals defined as “relatives” under the Income Tax Act are not taxed. However, if a gift is made to a non-relative and the amount exceeds Rs. 50,000 in a financial year, the recipient may be liable for tax on that amount.

Tax Implications Upon Change in Residential Status

The tax-exempt status of a Non-Resident External (NRE) account is directly linked to the holder’s residential status. When an individual’s status changes from a Non-Resident Indian (NRI) to a Resident Indian, the rules governing the account change. It is a mandatory requirement under the Foreign Exchange Management Act (FEMA) for the individual to inform their bank of this change, which triggers a re-designation of the account.

Upon notification, the bank will initiate the process of converting the NRE account. The account holder has two primary options: convert the NRE account into a standard resident rupee savings or fixed deposit account, or transfer the balance to a Resident Foreign Currency (RFC) account.

This conversion marks a shift in the account’s tax liability. Once the NRE account is re-designated as a resident account, the interest earned from that point forward loses its tax-exempt status. The interest income generated after the conversion becomes fully taxable in India and is added to the individual’s total income for the year.

Taxation in the Country of Residence

A common misunderstanding is that the “tax-free in India” status of NRE interest income means it is tax-free globally. This is not the case for residents of countries that tax worldwide income, like the United States. The U.S. requires its citizens and residents to report all income from all sources, so any interest earned from an Indian NRE account must be reported to the Internal Revenue Service (IRS).

For U.S. residents, the interest income must be reported on Schedule B (Form 1040), Interest and Ordinary Dividends. Additionally, U.S. persons with a financial interest in or signature authority over foreign accounts must file a Report of Foreign Bank and Financial Accounts (FBAR) if the aggregate value exceeds $10,000 during the year. This report is filed electronically using FinCEN Form 114 with the Financial Crimes Enforcement Network (FinCEN), not the IRS.

A separate requirement under the Foreign Account Tax Compliance Act (FATCA) may also apply. U.S. taxpayers holding specified foreign financial assets, including bank accounts, must report them on Form 8938, Statement of Specified Foreign Financial Assets. For a single individual living in the U.S., the filing threshold is met if the total value of these assets is more than $50,000 on the last day of the tax year or more than $75,000 at any point during the year.

A Double Taxation Avoidance Agreement (DTAA), such as the one between India and the U.S., is designed to prevent the same income from being taxed in both countries. This is often achieved by allowing a tax credit for taxes paid in the source country. However, since NRE interest is exempt from tax in India, no Indian tax is paid, and no foreign tax credit can be claimed on a U.S. tax return. The interest income is therefore fully subject to U.S. income tax.