Sep 26, 2017

Indian Bank Interest, When is this Truly Tax Free?

Arvinder Singh Matharu
Sep 26, 2017  |  Tax
A friend of mine, who is of Indian origin, was recently discussing with me how he had found a way to earn an eye watering 9% interest on cash deposits. He explained that deposits held in an Indian bank account typically earn interest of 7-9% and that he is earning a small fortune on his deposits.
 
Not meaning to bring my friend down to earth, I felt it necessary to make him aware of a few issues.
 
First, has he opened the right type of account in India? To give some background here, a person of Indian origin living outside of India is permitted to open a "special" type of bank account in India where the interest can be earned free of Indian taxes. However, it has to be the right account. There are two types of account - NRE and NRO. The account that needs to be opened in order for it to be free of Indian taxes is the NRE account. An NRO account will be exposed to Indian taxes. Fortunately for my friend, whilst he has open both the NRE and NRO accounts, his money is being held in the NRE account. So far so good then. The interest being earned will not be subject to Indian tax.
 
Second, what about exchange rate movements? On repatriation of the money back to the UK, will my friend make a loss on the original Sterling sum used to fund the Indian bank deposit even after the Indian interest is added on? To this my friend answered that he had deposited the monies just prior to the referendum on Brexit when Sterling was at a reasonable level. If he repatriated the monies back to the UK today, he would expect to make a nice profit given the fall of Sterling against the Indian Rupee. So, my friend was still smiling but the message here is that exchange rate movements should not be overlooked.
 
Third, what about UK tax? On asking this question, the wide smile my friend was wearing evaporated. What do you mean what about UK taxes? It's non-UK source income so it's not subject to UK tax, my friend protested. I explained that as he is UK resident, he is, in principle, subject to UK tax on his worldwide income and gains. However, there were circumstances in which it can be free of UK tax as follows.
 
If my friend was non-UK domiciled (domicile being the country in which he had a settled intention to reside permanently) and able to claim the remittance basis form of taxation, he could avoid UK taxes so long as he did not remit the interest to the UK. On discussion, my friend was unlikely to claim the remittance basis as he considered himself to be UK domiciled but, even if he could claim the remittance basis, it would not help him as his aim was always to bring the money back to the UK.
 
I raised the possibility of some or all of the interest potentially not being subject to UK tax if any of the personal allowance (currently £11,500), savings rate band (allows £5,000 of interest to be earned tax free depending on the level of other income) or savings allowance (allows up to £1,000 of interest to be earned tax free) is available. A big sigh came from my friend as he explained that he has none of these available and he is in fact a 45% taxpayer. This meant then that UK tax of 45% is due on the Sterling equivalent of the interest regardless of whether it has been repatriated to the UK. In a bid to cheer my friend up, I pointed out to him that paying tax on the income is a good thing as it meant that he had made money and he is richer because of it. Despite this and other attempts to cheer him up, that smile he had previously worn failed to reappear.
 
To make matters worse, my friend mentioned that his wife is of Indian origin and does not have any income. Had then the Indian bank account been opened in her name and the interest earned received by her, it would have been free of UK and Indian taxes. In this case, Indian bank interest would have been well and truly tax free.