NRI’s IRA withdrawals and interest earnings in India: Tax implications clarified

Key Takeaways:

1. IRA withdrawals representing salary and other income accrued when the applicant was an NRI would not be taxable in India, regardless of his residential status at the time of withdrawal.

2. Interest earned on the NR-NR-RD account in India would be taxable in the hands of the applicant (or the IRA custodian as a trustee) from the previous year in which the applicant ceases to be a non-resident.

3. The AAR declined to rule on the gift tax implications of gifting IRA funds to a resident in India, as it lacks jurisdiction over the Gift Tax Act.

Issue:

Whether the principal and interest earnings from the applicant’s IRA investment through the custodian bank in a non-resident non-repatriable rupee deposit scheme in India would be exempt from taxes, and whether the IRA withdrawals and gifts made from the IRA funds would be tax-exempt in India.

Facts:

1. The applicant, an Indian citizen, has been residing in the United States since 1968 and was an employee of a US company until his retirement in 1993.

2. During his employment, he entered into an Individual Retirement Arrangement (IRA) with a US bank (SIS), where he contributed part of his salary income on a tax-deferred basis.

3. The applicant planned to shift his residence to India and invest part of his IRA funds in a non-resident non-repatriable rupee deposit (NR-NR-RD) account with an Indian bank.

4. The IRA account would remain in the name of SIS (the custodian bank), and withdrawals would be credited to the NR-NR-RD account in Indian rupees.

5. The applicant sought rulings on the taxability of the IRA withdrawals, interest earnings on the NR-NR-RD account, and gifts made from the IRA funds to a resident in India.

Arguments:

1. The applicant argued that since the IRA withdrawals represented salary and other income accrued when he was an NRI, they should not be taxable in India, regardless of his residential status at the time of withdrawal.

2. Regarding interest earnings on the NR-NR-RD account, the applicant contended that they should be exempt from taxes in India, as the account would be in the name of the non-resident custodian bank (SIS).

3. The applicant also sought a ruling on the gift tax implications of gifting IRA funds to a resident in India.

Key Legal Precedents:

The AAR cited the following legal provisions and precedents:

1. Section 4 of the Income Tax Act, 1961:

Defines the scope of taxable income.

2. Section 6 of the Income Tax Act, 1961:

Determines the residential status of an individual.

3. Section 10(15)(i) of the Income Tax Act, 1961 and Notification No. SO 653(E), dated 31-8-1992:

Exempts interest income of non-residents from certain sources.

4. Ruling in P. No. 5 of 1995 (cited):

Discusses the concept of “resident but not ordinarily resident” (R-NOR) status.

Judgement:

The AAR ruled as follows:

1. The principal constituting withdrawals by the applicant from his IRA account in the US and deposited in the NR-NR-RD account in India would not be liable to tax, as these withdrawals did not constitute income in the applicant’s hands but represented salary and other income accrued when he was an NRI.

2. The interest earnings from the IRA account credited from time to time to the NR-NR-RD account would be liable to pay Indian income tax at the rates applicable to an individual from the previous year in which the applicant ceased to be a non-resident. Although the account would be in the name of the non-resident custodian bank (SIS), the applicant would be the true and full beneficiary, and the income would be taxable in his hands (or in the hands of SIS as his trustee).

3. The AAR declined to rule on the gift tax liability in respect of any gifts made by the applicant from the IRA funds to a resident in India, as it lacks jurisdiction over the Gift Tax Act, 1958.

FAQs:

Q1: Why were the IRA withdrawals not taxable in India?

A1: The IRA withdrawals represented salary and other income that had accrued to the applicant when he was a non-resident Indian (NRI). Since this income was not taxable in India at the time of accrual, the subsequent withdrawals would also not be taxable, regardless of the applicant’s residential status at the time of withdrawal.

Q2: Why were the interest earnings on the NR-NR-RD account taxable in India?A2: Although the NR-NR-RD account would be in the name of the non-resident custodian bank (SIS), the applicant would be the true and full beneficiary of the interest income. Therefore, the interest earnings would be taxable in the hands of the applicant (or SIS as his trustee) from the previous year in which the applicant ceased to be a non-resident.

Q3: Why did the AAR decline to rule on the gift tax implications?

A3: The Authority for Advance Rulings is constituted under the Income Tax Act, 1961, and lacks jurisdiction over the Gift Tax Act, 1958. Therefore, it could not provide a ruling on the gift tax liability arising from gifting IRA funds to a resident in India.

Q4: How was the applicant’s residential status determined?

A4: Since the applicant had been away from India since 1968, the AAR ruled that he was likely to continue to be a “resident but not ordinarily resident” (R-NOR) within the meaning of Section 6(2) of the Income Tax Act for at least 9 years after the year of his arrival in India, or potentially longer if he spent a short time in India in any financial year, making him a non-resident for that year.

Q5: What was the significance of the legal precedents cited?

A5: The AAR cited relevant sections of the Income Tax Act, 1961, to define the scope of taxable income (Section 4), determine residential status (Section 6), and apply the exemption for interest income of non-residents (Section 10(15)(i) and Notification No. SO 653(E)). The ruling in P. No. 5 of 1995 was cited to discuss the concept of “resident but not ordinarily resident” (R-NOR) status.

Full Text word to Word Order Authority for Advance Rulings.

1. The applicant, a non-resident, seeks, by this application, an advance ruling under Chapter XIX-B of the Income-tax Act, 1961 ('the Act').

2. The applicant is a citizen of India. He holds an Indian passport. From June 1968 till date, he has been resident in the United States. He was an employee of an American company from 14-10-1974 until retirement on 1-7-1993. His current occupation is management of personal business and consulting work in USA. Presently, the applicant is not assessed to tax in India.

3. During the period of his service with the American company, the applicant entered into an individual retirement arrangement ('IRA') with SIS, a banking institution, and a subsidiary of an American bank. Under section 408(a) of the United States Internal Revenue Code, the IRA is a trust account of which SIS is the custodian. Broadly speaking, contributions made to the IRA by employee-members are tax-deferred (i.e., they are tax deductible at the time of contribution but liable to tax at the time of their withdrawals by the applicant in due course). The applicant became a contributor to the plan in 1984. From time to time, funds in US dollars constituting part of the applicant's yearly taxable income were deposited in the IRA on tax-deferred basis. The SIS, as custodian of the IRA on behalf of the applicant, invested the funds in US market securities under the instructions of the applicant. No taxes were paid on the deposits as well as the earnings and gains credited to the investment account from time to time, such taxes being payable thereon only at the future date of withdrawal. By law, SIS has to provide an annual report to the Internal Revenue Service of the United States (IRS) and to the applicant about the IRA insofar as it concerns him. Withdrawals are permitted from the IRA only after an applicant reaches the age of 59& years and the applicant would become entitled to do this on or after 11-8-1997. As stated earlier, on such withdrawals, which are to be in accordance with a method approved by the IRS, the applicant has to pay the taxes thereon to the IRS as and when the withdrawals are made.

4. The applicant is planning to shift his residence to India and settle down here permanently. In anticipation, he intends to invest part of his IRA funds in a non-resident non-repatriable rupee deposit (NR-NR-RD) scheme with the Bank of America or some other financial institution. The applicant would be thus receiving future proceeds from the account in India to cover his retirement expenses. However, to ensure proper compliance with the scheme of annual reporting by the SIS, it is stated that the deposit in any such account will have to be made by SIS acting as IRA custodian for the applicant.

5. It will be seen from the above statement of facts that the applicant proposes to have an account with a bank in India in the name of SIS to which will be credited all withdrawals made by him from time to time from his IRA in Indian rupees and will be earning income therefrom by way of interest. In this context, two questions are facing the applicant on which he seeks a ruling from this Authority, particularly because, sometime after coming back to India, he will cease to be a non-resident and will be either a "resident but not ordinarily resident (R-NOR)" or a "resident and ordinarily resident (ROR)". The applicant wishes to know whether "during the period the IRA is active and even after the applicant becomes fully resident in India, it could be held true that—

(i)the principal and the interest earnings from the applicant's IRA investment through SIS in a non-resident non-repatriable rupee deposit scheme for NRIs will be exempt from all corporate and individual taxes in India?

(ii) he IRA withdrawals by the applicant will be tax exempt income in India.

(iii) the gifts made by the applicant from the IRA funds to a resident in India will be exempt from any Indian gift-tax for one time gifting ?"

6. As already stated, the applicant will be liable to pay tax in the US on the amounts of withdrawals made from the IRA. The applicant has stated that SIS will withhold taxes on the distributions/withdrawals reported to the IRS. The applicant has stated that, for this purpose, he plans to keep a portion of his IRA investment in US dollars at US itself and that no request will be made to the RBI to release any foreign exchange for tax payment.

7. It is in the above context of facts that the Authority has to give rulings on the three questions posed before it. It appears more convenient to answer the questions raised in the reverse order. The third question pertains to the applicant's liabilities under the Gift-tax Act, 1958. This Authority has been constituted under the Income-tax Act, and has no jurisdiction to give advance rulings on questions relating to taxes levied under other enactments on which this set of provisions has not been engrafted. The authority is, therefore, unable to give any ruling on the third question raised by the applicant.

8. To take up next the second question which pertains to the taxability of the withdrawals made by the applicant from his IRA account from time to time in the NR-NR-RD account and the interest earned thereon: In the opinion of the Authority, no tax will be payable in India by the applicant on such withdrawals whatever the residential status of the applicant at the relevant time may be since these withdrawals do not at all constitute income in his hands. The amounts lying in the IRA account with SIS in the US represent part of the salary income received by the applicant in earlier years and deposited in the IRA account as a form of compulsory savings augmented by interest, capital gain and other accretion thereto. The withdrawals mostly represent salary and other income which had accrued to the applicant at a point of time when he was a non-resident in India. He will, therefore, be liable to pay no Indian tax thereon. No such Indian tax liability can be attributed merely because, at a point of time later to their accrual, he chooses to bring those funds into India or merely because a part of those funds are treated as income and taxed by the US IRS at the point of distribution instead of at the original stage of accrual. To some extent, the withdrawals may represent income that may have accrued on the investments in the account subsequent to the applicant's arrival in India. But even on this, he will not be taxable so long as his status is that of a R-NOR. Since the applicant has been away from India since 1968, he is likely to continue to be a R-NOR, within the meaning of section 6(2) of the Act for at least 9 years after the year of his arrival in India. It could be more if, after his arrival in India, he happens, in any financial year, to be in India for so short a time as to make him a non-resident for that year. This concept has been discussed at some length by the Authority in the case of another applicant (P. No. 5 of 1995). It is only when a fairly long time has passed and the applicant becomes ROR - both resident and ordinarily resident in India - that the income accruing thereafter in his IRA account in the States may become taxable on accrual basis. As already indicated, this may be only after a period of about ten years and on the assumption that the IRA account continues till then without the applicant having withdrawn the entire amounts standing to his credit in that account. The second question raised by the applicant is answered accordingly.

9. This takes one to the consideration of the first question raised by the applicant and this pertains to the interest on the applicant's investments, in India, of funds withdrawn from his IRA investments from time to time in a NR-NR-RD account. It has already been pointed out that the principal amounts withdrawn from the IRA (whether from the deposits originally made or the income accrued thereon in the IRA account in US) and brought into India for the purposes of deposit in the NR account, will not be liable to Indian income-tax, save to the extent it accrues after the applicant becomes resident in India. So far as the interest earnings accruing from time to time in the rupee account in India is concerned, the position stands thus. The NR-NR-RD account, as already explained, will continue to stand in the name of SIS, a foreign company non-resident in India. The interest accruing in the account is exempt in the hands of a non-resident by virtue of a Notification No. SO 653(E), dated 31-8-1992, issued by the Central Government under section 10(15)(i) of the Act. Consequently, if the interest were accruing to SIS as the legal as well as the beneficial owner of the funds held under the IRA scheme, it will not be liable to tax in its hands by virtue of the above notification. But such income beneficially belongs to the applicant who would have become a resident by then (though for some years he may continue to be only R-NOR). The applicant, therefore, will be fully liable in respect of the income accruing in the deposit account in India of which he is the true and full beneficiary, the SIS being nothing more than a mere custodian.

Under the Act, a trustee or a custodian can be taxed for the income accruing to or received by or on behalf of a beneficiary but such assessment will have to be made in the same manner and to the same extent as if the assessments were being directly made on the beneficiary himself. That being so, the income earned in the NR-NR-RD account, though exempt from tax in the hands of SIS, will be liable to tax in the hands of the applicant (or of SIS as his trustee or custodian) once he ceases to be non-resident in India. The first question is answered accordingly.

10. For the reasons discussed above, the Authority pronounces the following ruling on the three questions raised by the applicant in Paragraph C of his application :

RULING

(1)The principal constituting withdrawals by the applicant from his IRA account in the US and deposited in the NR-NR-RD account in India will not be liable to tax. The interest earnings therefrom credited from time to time to the account will, however, be liable to pay Indian income-tax at the rates applicable to an individual from the previous year in which the applicant ceases to be a non-resident; and

(2)The IRA withdrawals by the applicant will not constitute taxable income and will not be liable to tax in India; and

(3)This Authority declines to give any ruling on the question pertaining to the gift-tax liability in respect of any gifts that may be made by the applicant from the IRA funds to a resident in India.