200311 tax nri
Recent iNchanges explained: How non-repatriable NRI investment in an Indian firm is now treated as domestic, not FDI Image Credit: Reuters

Dubai: India continues to be an attractive destination for investors, including non-resident Indians (NRIs). Earlier this week the government issued a clarification on how NRI investments would be treated within the country going forward, and this news spiked interest among UAE-based Indian expats.

However, there was a need to know how this norm can affect your investments, while also understand what has changed from the rule or practices that were previously in place. Moreover, is there anything you – as an NRI – should keep in mind when it comes to the latest investment-related change?

Dixit Jain

“Presently there were different interpretations on whether non-repatriable investments by NRIs should be considered domestically controlled or foreign controlled,” said Dixit Jain, managing director at The Tax Experts, DMCC.

“The fresh clarification settles the position that it will be considered domestically controlled,” Jain added. “This is a helpful clarification by the government.”

What is the latest change all about?

What we know so far is that India’s Department for Promotion of Industry and Internal Trade (DPIIT) issued a statement on Saturday that investment by NRIs on non-repatriation basis in an Indian company will be treated as domestic investment for the purpose of calculating indirect overseas capital inflows.

This change was brought into effect after the government reviewed the FDI (foreign direct investment) policy in relation to investments made by an Indian company owned and controlled by NRIs on a non-repatriation basis (explained below).

After which a clause was added in the FDI policy, in order to provide a clarity on downstream investments (explained below) made by NRIs. The clause was added in the guidelines for calculation of direct and indirect foreign investments.

What are ‘downstream’ and ‘non-repatriable’ investments?
Downstream investment is an indirect mechanism of FDI, whereby a company incorporated in India, which is owned and/or controlled by non-resident persons/entities (investing company), subscribes or acquires the shares of another Indian company.

Investment on repatriation basis means the sale or maturity proceeds of an investment, net of taxes, are eligible to be transferred out of India. In case of non-repatriation investments, this cannot be transferred out of the country under Foreign Exchange Management Act (FEMA).

What does all this mean for an NRI investor?

NRI investments that are repatriable are treated as foreign direct investment (FDI) while non-repatriable investments are considered as domestic investment.

However, existing guidelines clearly lay down that an Indian company is one that is both owned and controlled by resident Indians and violating any one condition makes the company foreign-owned.

So, simply put, investments by non-resident Indians (NRIs) that cannot be transferred out of the country are deemed to be treated like 'domestic' investments or investments made by the country’s residents.

According to consultants who specialise in NRI investment and taxation-related concerns, there have been a number of queries and confusion relating to this matter, in the months running up to the recent change – and hence what prompted the government to provide clarification on it.

This is a move for the convenience of calculation as an investment now made by an Indian entity which is owned and controlled by NRIs on a non-repatriation basis shall not be considered for calculation of indirect foreign investments.

To understand further how the recent regulatory changes affect NRI investments in companies, let’s also briefly look at a few of the popular investment options generally exercised by the NRIs:

Key considerations for NRI investments in India

Key considerations for NRI investments in India

Investments made by NRIs are generally treated as ‘foreign investment’ from the Indian foreign exchange regulations perspective. These regulations have been liberalised over the years and have facilitated remittances and investments from overseas.

1. Bank deposits: There are predominately three forms of bank accounts that may be opened by NRIs in India. These are: Non-Resident (External) Rupee Account Scheme (NRE Account), Non-Resident Ordinary Rupee Account (NRO Account); and Foreign Currency (Non-Resident) Account (Banks) Scheme (FCNR Account).

How NRE, NRO, FCNR investments are treated?
NRE accounts are primarily operated by the NRIs with an intent to park their foreign earnings/savings in Indian rupees. The ease of deposit and repatriation of funds from this account and interest being exempt from tax in India makes NRE Accounts a preferred option to park funds in India.

NRO account is preferred in cases where NRIs intend to park only the Indian-sourced income such as rent, pension or dividend earned and received in India. It is pertinent to note that unlike an NRE Account, interest earned in the NRO Account is taxable in India.

FCNR account is designated in foreign currency i.e. funds in this account can be maintained in any permitted currency, which is freely convertible. FCNR accounts thus provide ease of repatriation of funds as they are maintained in the designated foreign currencies, and protect from foreign exchange rate fluctuations. FCNR accounts can be maintained only in the form of fixed deposit accounts.

2. Company stock investments: Being a fast-growing large economy, investment into equity shares of Indian companies offers an attractive opportunity for investors. NRIs can invest in equity shares of both listed and unlisted companies, subject to certain conditions, sectoral restrictions, and other parameters.

An NRI can invest up to 5 per cent of the paid-up value of the shares of the listed company through a recognised stock exchange in India on repatriation basis, which is further subject to an overall limit of 10 per cent for investments by all NRIs, in case the company has investments from more than one NRI.

The 10 per cent limit can be increased to 24 per cent through a special resolution passed by the company. Such investment is treated as ‘foreign portfolio investment’ as per the foreign exchange regulations.

Investment in an unlisted company by an NRI on repatriation basis is treated as ‘foreign direct investment’, which is subject to stricter valuation/pricing norms, sectoral restrictions and reporting requirements.

However, NRIs can purchase equity instruments issued by a company without any limit either on stock exchange or outside it on a non-repatriation basis, subject to certain sectoral restrictions.

NRIs pay taxes on any transfer of shares
On transfer of shares, NRIs are required to pay capital gains tax in India. The rate of tax depends on the period for which the shares were held by the NRI before transfer and whether the shares are listed or unlisted.

Listed shares held for more than 12 months are subject to long-term capital gains tax at the rate of 10 per cent and those held for up to 12 months give rise to short-term capital gains, which are subject to tax at 15 per cent.

In the case of unlisted shares, the holding period should be more than 24 months to qualify as long-term capital gains, and the tax rate is same as listed shares that is10 per cent. However, short-term capital gains on sale of unlisted shares are taxable at the applicable slab rates.

3. Mutual funds: Broadly, the NRIs are allowed to purchase units of mutual funds without restrictions irrespective of the type of mutual fund that is whether it is equity-oriented or debt-oriented.

Similar to equity, return from investment in mutual funds is primarily in the form of dividends and governed by the similar taxing principles, as equity dividends.

Transfer/redemption of units of equity-oriented mutual funds held for a period exceeding 12 months are classified as long-term capital gains which are subject to tax at 10 per cent and those held for up to 12 months are classified as short-term capital gains which are taxable at 15 per cent.

In case of debt-oriented mutual funds, the holding period should be more than 36 months to qualify as long-term capital gains, which are taxable at 20 per cent, whereas those held for up to 36 months are classified as short-term capital gains and are taxable at applicable slab rates.

Mutual Funds
Picture used for illustrative purposes.

Other investments: In addition to the above, NRIs also invest in government securities, treasury bills, exchange traded funds, bonds issued by public sector undertakings and infrastructure debt funds, national plan/saving certificates, debt instruments issued by banks either on repatriation basis or non-repatriation basis. The tax implications would vary with the type of instruments.

Also, investment into real estate is another popular investment avenue with the NRIs, as they generally want to have a base/connect with India.

The current pandemic and the lockdowns have severely impacted the global economy and India is no exception. However, considering the potential of the Indian economy and likely growth in near future, the above instruments, along with other investment options, still remain attractive for the NRIs to continue remitting funds and investing in India.

NRIs can also avail of the benefit of lower tax rates under the Double Tax Avoidance Agreement between India and the country of their residence, as applicable.