The rise of the Silicon Valley in the US saw a lot of Indians move base in search of a better and brighter future. After securing their and their family’s future, these individuals are now repatriating back to their homeland after retirement. Generally, Indian residents are taxed on worldwide income. An individual who is an NRI, or an individual who is a resident but not ordinarily resident (RNOR) is only taxed on the Indian source of income. But how does this affect their retirement funds/ foreign retirement accounts (FRA) once they move to India and become residents? Are they taxed? Is there any tax relief?
This was confusing and gave rise to a host of issues mainly due to a difference in taxation laws. In the US, there are no tax implications on periodic accruals to a 401(k) or an Individual Retirement Account (IRA) until the time of withdrawal. On the other hand, in India, the accruals were taxable every year depending on the residential status of the individual. So, the tax was paid twice – first during the accruals, and second during the withdrawal. Since taxation in India preceded taxation in the US (taxed during different periods), it posed a difficulty while claiming credit and the individual inevitably ended up paying double the taxes.
A brief overview of the Retirement accounts in the US
- 401 (k) – This plan is offered through employers. The contributions by the plan holder will be matched by the employer. The amount contributed to a 401(k) is deducted from taxable income. Withdrawals called ‘Required Minimum Distributions’ need to be done starting at the age of 72 of the plan holder. Funds are subject to tax only upon withdrawal.
- Solo 401(k) – this plan is for those who are individual business owners without any workers.
- 403(b) – This plan is available for those working for a non-profit or a tax-exempt organization. Earnings grow tax-free until withdrawn
- IRA – An individual retirement account, this is available only to those with an earned income. A tax deduction is received for the money put into an IRA. It will be considered taxable only upon withdrawal.
- Roth IRA – Like an IRA it is available only to those with an earned income. Unlike an IRA, taxes are to be paid on the amount contributed to a Roth IRA. But, the money grows tax-free and no tax is due on IRA withdrawals.
- SIMPLE IRA – Available to those who work in a small business with 100 or fewer workers. Amount contributed will be deducted from taxable income., but attracts tax upon withdrawal.
All of these retirement accounts will be termed as Foreign Retirement Accounts in the Indian Context when the plan-holder moves to India and becomes a resident.
Changes made by Budget 2021
Acknowledging the aforementioned difficulty faced by many NRIs, Budget 2021 introduced a new Section, Section 89A in the Income Tax Act, 1961. It states that when a specified person has income accrued in a specified account, it will be taxed in such a manner and year as prescribed by the Central Government.
‘Specified person’ here refers to a person who is now a resident in India who opened a specified account in a notified country while being a non-resident in India, and a resident of the said notified country.
‘Specified account’ here refers to an account maintained in a notified foreign country by the person for retirement benefits. The income from such an account is not taxed on an accrual basis but only at the time of withdrawal or redemption.
With this change, individuals with foreign retirement accounts will be secure from double taxation. The amendment will take effect from April 1, 2022, and will accordingly apply in relation to the assessment year 2022-23 and subsequent assessment years.
Giving effect to the changes
The rules for the changes have just been notified by the Central Board of Direct Taxes (CBDT) under Rule 21AAA for the US, UK, and Canada.
- According to the new rules, where income has accrued in the FRA of an individual, he has two options. He can either include this income in his total taxable income in India in the year of accrual, or in the year when such income is taxed at withdrawal or redemption in the US.
Illustration- Mr. Kapoor has $500,000 in his FRA. He earns an income of $8,000 per year in this account. So, he earned $8,000 in 2021-22 as well. He can choose to get this income added to his total income for the FY 2021-22 and get taxed for the same, or he could choose to defer and get it taxed at a later year of redemption.
The total taxable income cannot include the income from the FRA if the income was already included in the total income in the previous years during which income was accrued and relevant taxes were paid for such income.
It is also not included if such income was not taxable in India due to the residential status of the individual or on account of DTAA.
- The new rule, which applies from FY 2021-22, allows the person to exercise an irrevocable option to have the FRA taxed only in the year of withdrawal or redemption. Taxes paid in the US can be adjusted against taxes paid in India. This change, however, is applicable only prospectively from 2021-22. Credit cannot be claimed on the income that was taxed when it accrued in the earlier years. The option can be exercised by filing form 10EE before the due date of filing the income tax return. All FRAs need to be disclosed and the option can be exercised only once i.e. it cannot be changed subsequently. The option should also be exercised on all specified accounts by the specified person.
Illustration- If Mr. Kapoor decided to go with the second option of taxation only at withdrawal, he will have to file form 10-EE before the due date for filing the ITR.
Form 10-EE requires the following information-
- Name of the specified person
- PAN of the specified person
- Address of specified person
- Previous year in respect of which option is being exercised
- Details of all specified accounts, including account number, name of the retirement fund, name of the notified country, balance as on the last day of the financial year prior to the previous year for which this form is being filled, year in which the account was opened.
- If the person has become a non-resident again after exercising this option, then it shall be deemed that he has never exercised that option. The income accrued in the specified account or accounts beginning from the previous year in which such option was exercised shall be taxable in his hand and tax shall be paid on or before the due date for furnishing ITR.
Some other changes that have been made are reflected in the ITR forms. All ITR forms now have new rows where details of the income accrued on foreign accounts have to be reported. This will also include any income that is to be claimed under tax relief under Section 89A. In the old ITR forms, under Schedule FA, assets had to be reported only if it was held during the relevant accounting period and the term “accounting period” was not defined. This term has been replaced entirely with “calendar year ending December 31, 2021”. This removes any scope of misunderstanding and confusion.
Financial planning for NRIs
Retirement planning for NRIs involves making more decisions than a non-NRI would. Multiple questions will have to be answered. Decisions have to be made regarding whether or not to move out of the US and back to India. Comparisons have to be made as to where can the pre-retirement lifestyle be maintained without much financial strain. Things like exchange-rate, inflation, and personal factors like health issues will also have to be taken into account.
The very first decision to be made should be the country of retirement. Have a look at the taxes you have to pay if you choose to remain in the US post-retirement. If you move to India, you have to keep in mind the tax implication on your retirement accounts as seen in this article.
After tackling that decision, you need to find suitable investment options and diversify your portfolio. There is a multitude of options available for an NRI to start investing in India even before retirement.
To help guide you through such tough decisions while keeping your finances in mind, take the help of a CFO consulting service.