A large number of non-resident Indians (NRIs), who make earnings in foreign exchange, keep money in India in non-resident ordinary (NRO) account. The RBI regulations provide that the balance in the NRO account is not eligible for remittance outside India without the approval of RBI. Therefore, it is commonly believed that NRO deposit cannot be regarded as a foreign exchange asset, and that the interest earned on NRO account will be taxed in India at the normal rate of 30%.

The above controversy was raised before the Authority for Advance Ruling (AAR) in a recent case of V Ravi Narayanan (300 ITR 62). The assessee, an NRI having spent more than 182 days outside India, claims the status of a non-resident individual. He proposes to open a NRO account with banks in India with the help of foreign remittances. He claims that interest income arising from that account will be "investment income" of the Income-tax Act.

In the light of the above facts, the following questions were referred to AAR:

1. Whether the NRO deposit acquired with convertible foreign exchange can be treated as a 'foreign exchange asset'?
2. Whether the interest on such NRO deposits can be treated as 'investment income' and liable to be taxed at 20 per cent only?
3. At what rate tax is required to be deducted at source by the person responsible for paying such interest?

The term "foreign exchange asset" is defined in section 115C as under: "foreign exchange asset means any specified asset which the assessee has acquired or purchased with, or subscribed to in, convertible foreign exchange". In the above context, the Department argued that since the NRO deposit is not repatriable, it is not a foreign exchange asset. On the other hand, the assessee argued that section 115C nowhere says that the asset acquired should be repatriable; the only condition attached is that the asset should have been acquired with the help of convertible foreign exchange.

The AAR agreeing with NRI ruled "We also find that repatriability of the balance in the bank deposit is not a requirement of the relevant provisions of law. There is no whisper at all about this either in section 115C or 115E. Thus, the NRO deposit would be a foreign exchange asset."

Section 115E provides for a concessional rate of tax on investment income arising to Non-resident Indians. The investment income is taxed at the rate of 20%. Investment income is defined to mean any income derived from a foreign exchange asset. Thus, if the deposit in NRO account is treated as a foreign exchange asset, the interest income will also fall in the category of investment income, which is taxable only at the rate of 20% as against the normal rate of tax, which could be 30%.

The AAR therefore held that "income by way of interest earned from the said NRO deposit shall be treated as "investment income" under clause (c) of section 115C and shall be liable to be taxed at the rate of twenty per cent under section 115E".

In respect of deduction of tax at source, the AAR ruled that "the banks paying interest on the NRO deposit of the applicant are required to deduct tax at source at the rate of 20%".
The ruling given by the AAR in the above landmark judgment will go a long way to help NRIs to pay a lower tax in India on NRO deposits.

By Ms.Bobby Aanand, Metropolitan Jury.

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