NRE Bank FD or Money Market (Liquid) Fund?
NRE Bank FDs have always been considered the best investment product for NRIs to earn SECURED, TAX-FREE return in India. NRIs have poured in BILLIONS of dollars in NRE bank deposits to generate Secured tax-free return in India. However, with change in global compliance and reporting requirements to report foreign income and increasing currency risk of rupee (INR) depreciation, it is not that crystal clear any more.
Let’s understand it with an example.
Mr. A, an NRI from USA, has Rs. 10,000,000 on December 31, 2010 that he wants to invest for 5 years to generate Secured after-tax return in India. He does not want any regular income and wants to repatriate the funds back to USA after 5 years. The interest on NRE FD is assumed to be 10% and so as the return on money market / liquid funds.
Option A:
He invest the amount in 5 year NRE Bank FD on January 1, 2011 generating 10% interest on a cumulative basis payable on maturity. As Mr. A is from USA, he would need to include the interest income converted into USD at different rates as income in his US tax return. As a result, he would include $102,225 in his income over 5 year period as shown in the table below:
| Tax Year | INR/USD | Interest (INR) | Interest (USD) |
| 2011 | 52.25 | 1,000,000 | $19,139 |
| 2012 | 54.45 | 1,100,000 | $20,202 |
| 2013 | 61.50 | 1,210,000 | $19,675 |
| 2014 | 63.20 | 1,331,000 | $21,060 |
| 2015 | 66.10 | 1,464,100 | $22,150 |
| 6,105,100 | $102,225 |
All the INR/USD rates for relevant dates are taken from the Department of US Treasury website.
Assuming his marginal tax rate is 30%, he would pay $30,668 as taxes in those 5 years. After 5 years, his investment would become $243,648 (16,105,100/66.10).
Option B:
If Mr. A had invested in money market (liquid or liquid plus) mutual fund giving 10% return compounded annually, his income would be calculated as follows:
| Tax Year | INR/USD | Value as on Jan. 1 (USD) | Value as on Dec. 31(USD) | Gain (USD) |
| 2011 | 52.25 | $218,818 | $210,526 | ($8,292) |
| 2012 | 54.45 | $210,526 | $222,222 | $11,696 |
| 2013 | 61.50 | $222,222 | $216,423 | ($5,799) |
| 2014 | 63.20 | $216,423 | $231,661 | $15,239 |
| 2015 | 66.10 | $231,661 | $243,648 | $11,986 |
| $24,829 |
Overall, Mr. A would include $24,829 as income and pay only $7,449 as taxes over 5 years.
As per US tax laws, investments in Mutual Funds are considered as investment in PFIC (Passive Financial Investment Company) and may be taxed based on the valuation on an annual basis. While loss may not be adjusted with other income, it would change the adjusted basis (cost) and can be adjusted against future income of same fund.
Reporting of unrealized gain on mutual fund is unique only to USA. If Mr. A had been from other country e.g. Australia and if he sold the mutual fund on Dec 31, 2015, he would report the capital gain and pay tax in A$ in the year of sale i.e. only in 2015. Assuming currency rates are of A$, the gain of $24,829 would be reported only in 2015.
Summary:
By investing in money market mutual fund, Mr. A could have saved $23,219 i.e. Rs. 15.35 lakhs in taxes. If he is in the 40% tax bracket, he could save $30,958 (20.46 lakhs) over 5 years.
WHY?
This is because of the nature of income.
Income from NRE bank FD is in the nature of an Interest, whereas income from money market mutual fund is in the nature of capital gain. Usually interest accrues in INR and is converted into foreign currency (USD/GBP/EUR/A$) annually, whereas the capital gain is calculated in foreign currency getting benefit of INR depreciation.
My Suggestions:
Until now, a lot of NRIs were not showing any accounts in India or reporting any Indian income in their tax returns. However, with changing dynamics of automatic exchange of information among various countries (FATCA/CRS) and steps taken by Indian government to gather and report all the income and account information owned by NRI, it would be extremely difficult to hide any investment or account by NRI in India. So, they would have no option but to disclose their income in India in their tax return and pay tax.
As a result, my advice would be:
- If you are an NRIfrom tax-heaven countries where you do not have to pay tax on your foreign income, e.g. Dubai, Singapore, etc., NRE FD is still be best investment option to generate secured tax free return in India.
- However, if you are an NRI from a country that tax foreign income(e.g. USA, UK, Australia, etc.), NRE FD may not be the right investment for you. You could bebetter off investing in money market (liquid/liquid plus) investment.
Assumptions/Disclaimers:
- This is assuming similar return in NRE FD and liquid / liquid plus mutual fund, which usually is the case.
- This is assuming rupee will depreciate in future. If rupee appreciates, you would have to pay more tax. However, you may not feel bad as your investment value has increased in dollar terms. Historically, INR has depreciated against USD since 1947 and it is prudent to expect rupee depreciation of 3.5%-4% per year.
- Please consult your CA/CPA/Tax attorney in the country of your residence and understand the taxation of Indian Income before making any decision or contacting us.
- Money market investments may or may not be right for you depending on other considerations. Please contact us to determine if this is the right solution for your needs.
