Income accumulated in Indian retirement funds such as PF & PPF are typically taxed in the year of withdrawal and not in the year of accrual. However, in the absence of a specific provision in the Indian tax law that deferred taxation even in respect of foreign retirement funds, the income earned from such funds (interest / dividends / capital gain distributions) would usually be treated as taxable in each year.  In order to cure this mismatch, the Budget 2021 has proposed to insert Sec. 89A which as per author CA Rohini Ramya (Partner, Taxkode Consulting LLP) will hopefully provide relief to individuals caught in the dilemma of the differing tax treatments in India versus the country in which the fund is maintained. While the author welcomes the said amendment, he also ponders over the taxability of income that accrued into such foreign retirement funds in past years and until 31 March 2021 considering the amendment is made effect prospectively.  The author also ponders over some other aspects such as the actual mechanism of the relief, Foreign Tax Credit for any foreign taxes paid on doubly taxed income etc.

Budget 2021: Relief from double taxation for non-resident Indians (NRIs)

Every year we witness the same old refrain – different versions and different reasons but usually requesting the same outcome - tax sops, increase in tax deductions / exemptions, reduction in tax rates, etc.  This year was a little different with louder requests due to the pandemic’s bruising financial impact and whispered doubts on the arsenal left in the Finance ministry’s armoury to deal with the nation’s fiscal problems.

The fervent prayers of the salaried class to reduce the taxes have not been answered, but at least the tax rates have not been increased. 

One pleasant surprise is the relief provided on the tax in respect of foreign pension funds.  This has been a long-standing request impacting persons of Indian origin / Indian nationals who may have lived and worked outside India before repatriating to live in India. 

Individual Retirement Accounts (IRA) / 401k

A 401k is usually offered by a US employer to employees to set aside funds towards retirement.  The employer may either not contribute or may match employee contributions into the 401k up to specified limits.  An IRA is similar to the 401k, except it is not offered by an employer but by a bank or a broker.

Contributions into a traditional 401k / IRA provide tax benefits to an employee in the year contributions are made.  Accruals in the fund are typically not taxed until withdrawal.  While some withdrawal may be permitted for special personal circumstances, in most cases withdrawal without penalty is permitted to individuals between 59.5 - 72 years.  Most individuals choose to postpone withdrawal at least until they turn 59.5 years of age to avoid the penalty that is levied on early withdrawal.   

India tax impact

Income accumulated in Indian retirement funds, similar to the 401k / IRA, are also typically taxed in the year of withdrawal and not in the year the income accrues.  As an example, the interest accrued on your PF account is currently not taxed until withdrawal and may even be completely tax exempt if the continuous service condition of 5 years is met at the time of withdrawal.   

Going forward, there is a proposal in the Budget 2021 to tax interest accruals in respect of contributions made into a recognized Provident Fund (PF) account / Public Provident Fund (PPF) account, where such contributions have exceeded Rs 250,000 during the year.  Nevertheless, in general, the accrual is not treated as taxable income until withdrawal.  

However, in the absence of a specific provision in the Indian tax law that deferred taxation even in respect of foreign retirement funds, the income earned from such funds (interest / dividends / capital gain distributions) would usually be treated as taxable in each year. 

Budget 2021 proposal

A new section 89A is proposed to be introduced that will hopefully provide relief to individuals caught in the dilemma of the differing tax treatments in India versus the country in which the fund is maintained.  This ought to then correct the mismatch in the year in which the income from such funds is taxed – currently in the year of withdrawal in the foreign country and in the year of accrual as per current Indian tax law. 

Questions

The changes are proposed to be prospective in nature, applicable from 1 April 2021 onwards if passed as such.  This leaves open questions on the taxability of income that accrued into such foreign retirement funds in past years and until 31 March 2021, warranting unnecessary litigation if not addressed before the Bill is passed.

Further details are also awaited on the actual mechanism of the relief, since the manner in which the tax is calculated, the year in which it will need to be offered to tax (presumed to be the year of eventual withdrawal), the notification of the country identified for the relief as well as the ‘specified fund’ in respect of which the relief would apply are awaited. 

Clarity on permitting Foreign Tax Credit for any foreign taxes paid on doubly taxed income would also be welcome.