NRI taxation: How to claim special tax concessions

Mint

06-06-2025

MUMBAI
:
Non-resident Indians (NRIs) and Persons of Indian Origin (PIOs) often maintain a financial footprint in India through shares, deposits, or other financial instruments. However, many are unaware of the benefits of the Income Tax Act's sections 115C and 115I, which provide concessional tax treatment on certain incomes.
Mint explains who can claim these benefits on which assets and when.
The types of income that qualify for concessions
The concessions apply to two specific types of income.
'The special tax provisions apply to income from foreign exchange assets such as interest, dividends, etc., or anything derived from specified foreign exchange assets. Long-term capital gains (LTCG) from the sale of foreign exchange assets are also covered," said Hardik Mehta, managing committee member, Bombay Chartered Accountants Society.
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However, Laxmi Ahirwar, director at chartered accountant firm P.R. Bhuta & Co, clarified that NRIs can not claim any deduction under Chapter VI-A (sections 80C to 80U), adding that even the indexation benefit on LTCG is not available.
Foreign exchange assets
The definition of a foreign exchange asset is strictly linked to the source of funds. 'Specific assets acquired or purchased with, or subscribed, using convertible foreign exchange are classified as foreign exchange assets. These are: shares in a private or public limited Indian company, debentures issued by a public limited Indian company, deposits with a public limited Indian company, any security issued by the central government, or any other security that the central government may specify by issuing a notification," explained Ahirwar.
Mehta added: 'When you transfer US dollars from your foreign bank account to your non-resident external (NRE) account, these funds are initially converted into INR before being deposited into the NRE account. Consequently, if equity shares are bought utilising funds from the NRE account, they are considered as foreign exchange assets. However, if the same shares are acquired using domestic funds from the non-resident ordinary (NRO) account, they will not qualify for the preferential tax rate under the special tax provisions."
Funds transferred from NRO to NRE
According to Ahirwar, funds routed through NRE accounts are generally eligible for concessional tax treatment under sections 115C to 115I of the Income Tax Act, provided the investment is made using foreign exchange remitted into India. In contrast, investments made using funds from NRO accounts are not eligible, as these typically consist of income earned or accumulated within India.
A frequent point of confusion arises when funds are transferred from an NRO to an NRE account using Forms 15CA and 15CB, a process permitted under the Foreign Exchange Management Act (FEMA). However, Ahirwar clarified that simply moving funds in this manner does not automatically qualify them for tax concessions. The key factor remains the original source of the money—it must have been inwardly remitted in convertible foreign exchange, not generated or retained domestically.
'This area is often subject to litigation," Ahirwar noted, 'as tax authorities may ask for proof that the investment was made from genuine foreign exchange inflows and not converted from Indian income."
Even if the funds sit in an NRE account, the origin trail must be clearly established.
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Ahirwar added that case laws have consistently emphasized that the source of funds takes precedence over the type of bank account used. Therefore, taxpayers must maintain proper documentation, such as bank remittance advice or foreign inward remittance certificates, to demonstrate compliance and claim concessional tax treatment with confidence.
Under Section 115E, the tax rates are fixed and applied on a gross basis. Mehta shared that 'as per Section 115E, the special tax rate on investment income is 20% and on LTCG 12.5%. The above taxation is on a gross basis, and no deductions or indexation benefits are available to the assessee.
For those reinvesting their LTCG, Mehta added, 'LTCG is exempted from tax if net consideration is invested within six months from the date of sale in another foreign exchange asset or a savings certificate."
If the price of a new foreign exchange asset is less than the net sale consideration, the exemption would be computed proportionately. A three-year lock-in would be applicable to the new foreign exchange asset purchased.
'If the new asset is transferred or sold within three years of purchase, then the exemption claimed earlier will be taxable in the year in which the new asset was transferred or sold," he explained further.
For example, Mr A sells shares that qualify as foreign exchange assets for ₹10 lakh and earns LTCG of ₹2 lakh on the sale. Per Section 115E, this LTCG would typically be taxed at 12.5% on a gross basis. However, if the NRI reinvests the entire net sale proceeds within six months in any specified asset or any other assets as the central government may specify, the LTCG can be exempted from tax.
But Mr A reinvests only ₹8 lakh out of the ₹10 lakh net sale consideration into a specified asset. Because the reinvestment is less than the net sale consideration, the exemption on the LTCG will be computed proportionately. This means the exempted LTCG will be calculated as (LTCG/net sale consideration) multiplied by the amount reinvested.
In this case, ( ₹2 lakh/ ₹10 lakh × ₹8 lakh) ₹1.6 lakh would be exempt from tax. The remaining ₹40,000 would be taxable.
Furthermore, the new foreign exchange asset bought with the reinvested amount will have a mandatory lock-in period of three years. If the NRI sells or transfers this new asset before the completion of three years, the earlier exemption claimed on the LTCG will be reversed and taxed in the year of such transfer or sale. This rule ensures that the reinvestment is maintained for a minimum period to qualify for the exemption.
Continuous tax exemption
Even after the initial three-year lock-in period, NRIs can continue to enjoy exemptions on LTCG, provided the proceeds from the sale are reinvested into eligible foreign exchange assets within the stipulated time. 'The tax exemption on LTCG doesn't have to be a one-time benefit," said Gautam Nayak, a chartered accountant. 'If the sale proceeds are reinvested into qualifying assets within six months, and those assets are held for the required period, the exemption can be carried forward indefinitely with each reinvestment cycle."
This reinvestment must occur within six months of the sale of specified assets.
Nayak explained that maintaining a proper documentary trail is critical in such cases. 'NRIs must be able to demonstrate that the original investment was made using convertible foreign exchange and that each subsequent reinvestment complied with the conditions specified under the Income Tax Act."
Without clear proof of the source of funds and asset eligibility, claims for exemption may not hold up during assessment or scrutiny.
For example, an NRI invests ₹20 lakh in shares using funds from their NRE account. After one year, the investment grows to ₹40 lakh. To claim the capital gains exemption, the entire ₹40 lakh must be reinvested within six months into another qualifying foreign exchange asset.
After holding the new asset for the required three years, if its value increases to ₹60 lakh and is sold again, the exemption can still be preserved, provided the ₹60 lakh is reinvested once more into an eligible asset within six months.
This cycle of reinvestment and exemption can continue as long as the NRI complies with the reinvestment timeline, asset eligibility, and documentation requirements.
Even after an NRI returns to India and becomes a resident, they may continue to enjoy these concessions under certain conditions. 'NRIs returning to India can continue being governed under these special provisions for their investment income (except interest, dividend income on shares in an Indian company) by furnishing a declaration to the assessing officer, along with their income tax return (ITR)," Mehta explained.
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'If an NRI becomes a resident in India in any subsequent year, he may submit a return of income along with a written declaration to the assessing officer stating that the special tax provisions should continue to apply to their investment income from foreign exchange assets," Ahirwar added.