Section 115E — NRI Tax Rates: 20% - 12.5%

Case Laws & Commentary

Section 115E — Tax on Investment Income and Long-Term Capital Gains

Chapter XII-A: Special Provisions Relating to Certain Incomes of Non-Residents

1. Statutory Snapshot

Where the total income of an NRI includes investment income or LTCG on a foreign exchange asset, income-tax is charged as follows (s. 115E):

• Investment income (e.g., interest from foreign exchange assets) — 20%;
• LTCG arising from the transfer of a foreign exchange asset — 10%;
• the balance of total income — taxed as if it were the total income, i.e., at normal slab/rates.

Surcharge and health & education cess apply on top; the 20%/10% are flat rates (no basic exemption set-off against the special-rate income and — per s. 115D — no deductions or indexation).

2. Commentary

2.1 A charging-rate provision, not a head of income

s. 115E does not create a new head; it overrides the rate at which Chapter XII-A income is taxed, leaving head, year of accrual and residence to the general scheme. The 20%/10% applies only to income that has first passed the s. 115C gateway and the s. 115D computation filter.

2.2 Interaction with DTAAs and s. 90(2)

Where the NRI is resident of a treaty country, the lower of the Chapter rate and the DTAA rate applies (s. 90(2)). For interest/dividend, many treaties cap the rate at 10–15%; the assessee may elect the treaty rate (subject to TRC and Form 10F). The Chapter and the treaty are alternatives to be optimised, not stacked.

2.3 Interaction with ss. 111A / 112 / 112A

STCG on equity (s. 111A) and the general LTCG regime (ss. 112/112A) operate independently. For listed-equity LTCG the assessee should compare the s. 112A regime (with its annual exemption threshold and 12.5% rate) before defaulting to the 10% Chapter route. Model both.

3. Key Issues / Practice Points

• Classify each stream precisely: investment income (20%), foreign-exchange-asset LTCG (10%), 'balance' (normal slab).
• Apply the lower of the Chapter rate and the DTAA rate; keep TRC + Form 10F + (where relevant) a no-PE declaration.
• Mind the surcharge slabs (and the 15% surcharge cap on certain gains/dividend) and 4% cess.
• For listed-equity LTCG, compare s. 112A against the 10% Chapter route.

4. Case Laws

Facts

• The assessee, Dr. M. Manohar, was a non-resident Indian who had made deposits with banks/companies in India out of funds brought by him from abroad. As these deposits were funded by convertible foreign exchange and answered the description of 'specified assets', they were foreign exchange assets within s. 115C.
• On maturity the assessee periodically renewed the deposits, rolling over both the original principal and the accrued interest into fresh deposits — so that successive deposits contained an 'interest-on-interest' element.
• For AY 1996-97 the assessee claimed the concessional treatment under s. 115H not only on the interest referable to the original foreign-currency-funded principal, but also on the interest earned on the re-deposited interest portion, contending it was traceable to the original foreign exchange asset.
• The Commissioner of Income Tax declined the concession on the interest-on-interest, holding that interest which had accrued in India on the re-deposited interest did not acquire the status of an investment made with foreign exchange. The Tribunal upheld that view; the assessee carried the matter to the High Court.

Question(s) for determination

Whether interest earned on a deposit made out of interest income (i.e., re-deposited interest) qualifies for the concessional rate under s. 115H as 'investment income derived from a foreign exchange asset', on the footing that it is ultimately traceable to the original foreign-currency-funded deposit.

Rival contentions

• Assessee: the interest on interest is traceable to, and a continuation of, the original foreign exchange asset; a beneficial, source-tracing construction should apply. Reliance was placed on RBI Circular No. 4 dated 11.02.1987 (referred to in the decision reported at [1987] 165 ITR 320).
• Revenue: ss. 115H/115C confine the concession to investment income derived from a foreign exchange asset that retains its specified-asset character; interest accruing in India on the re-deposited interest is fresh Indian-source income and is not an investment made with convertible foreign exchange.

Decision & reasoning

The Court read s. 115H as imposing two conditions: (i) the assessee must file a declaration along with the return for the assessment year in which he first becomes assessable as a resident, seeking the benefit; and (ii) the benefit continues only in respect of income derived from a foreign exchange asset falling within the 'specified assets' definition in s. 115C(f)(ii) to (v), and only so long as each asset retains its character as a foreign/specified asset.

On the plain language, the Court held the concessional levy is available only to investment income derived from the foreign exchange asset. The interest on the re-deposited interest had accrued in India and did not acquire the status of an investment made with foreign exchange.

The RBI circular relied on by the assessee was held to have no relevance to the assessee's situation.

Finding the section clear and free from ambiguity, the Court saw no ground to enlarge the concession and confirmed the order of the Tribunal against the assessee.

Ratio decidendi

The s. 115H/115E concession attaches to investment income derived from the original foreign exchange (specified) asset and is not infinitely inheritable; second-generation, Indian-source accretions (interest on interest) fall outside it.

A clear statutory concession is applied on its own terms; a beneficial RBI/administrative circular cannot enlarge the statutory benefit.

Application to this section

Defines the outer boundary of the s. 115E concessional rate: it follows the foreign exchange asset and the income genuinely derived from it, not every downstream rupee accretion. Interest on re-deposited interest is taxed at normal rates, not the 20% Chapter rate.

Practice note: The single most-cited High Court authority on s. 115H. Useful both offensively (to fix the eligible income on becoming resident) and defensively (to resist Revenue attempts to tax non-forex accretions at normal rates only where the income genuinely flows from the forex asset).

Facts

• The assessee, a non-resident Indian, filed a return for AY 2006-07 declaring income of Rs. 60,000.
• He held shares in Indian companies. It was undisputed that the original shares had been acquired by investing convertible foreign exchange, making them foreign exchange assets. Bonus shares had subsequently been allotted to him on those original shares.
• On the transfer of shares, the assessee claimed Chapter XII-A benefit (s. 115F), treating the bonus shares also as foreign exchange assets.
• In the assessment under s. 143(3), the Assessing Officer refused to treat the bonus shares as foreign exchange assets, denied the s. 115C/115F benefit, and assessed the total income at Rs. 11,23,265.
• The CIT(A) upheld the AO, reasoning that s. 115C(b) defines a 'foreign exchange asset' as one acquired or purchased with, or subscribed to in, convertible foreign exchange, whereas bonus shares were issued free and were neither acquired, purchased nor subscribed for by the assessee. The assessee appealed to the Tribunal.

Question(s) for determination

Whether bonus shares received in respect of original shares (admittedly acquired in convertible foreign exchange) are themselves a 'foreign exchange asset' within s. 115C(b), so as to be eligible for the s. 115F exemption.

Rival contentions

• Assessee: bonus shares cannot be divorced from the original forex-funded shares; on issue of bonus shares the cost of the original shares is spread over the enlarged holding, so the forex character of the original investment flows to the bonus shares.
• Revenue: the words of s. 115C(b) require acquisition/purchase/subscription in convertible foreign exchange; bonus shares involve no such payment and therefore fail the statutory test.

Decision & reasoning

The Tribunal held that the assessee had acquired the original shares by investing convertible foreign exchange, and the bonus shares cannot be considered in isolation from those original shares.

It noted that the Supreme Court and various High Courts have settled the valuation of bonus shares: the cost of acquisition of the original shares is to be spread over both the original and the bonus shares (the averaging method), because on issue of bonus shares the value of the original shares is proportionately diminished — the holding is, in effect, 'split up'. The cost and value of the original and bonus shares are therefore closely interlinked and interdependent, and once bonus shares are issued the averaging formula applies to the whole holding.

Applying that principle, the bonus shares partake of the character of the original (forex-funded) shares and are covered by s. 115C(b) as a foreign exchange asset; they are accordingly eligible for benefit under s. 115F.

The appeal of the assessee was allowed.

Ratio decidendi

The forex character of an original foreign-currency-funded shareholding flows through to bonus shares issued on it; bonus shares are a 'foreign exchange asset' under s. 115C(b) and qualify for s. 115F.

The cost-averaging principle for bonus shares (the Dalmia Investment line of authority) governs both the characterisation of the bonus shares and the quantification of the qualifying gain.

Application to this section

Confirms that once an asset is characterised as a foreign exchange asset (here, bonus shares), the resulting LTCG is taxed at the 10% s. 115E rate (and is eligible for s. 115F) — i.e., characterisation under s. 115C drives the s. 115E rate.

Practice note: The leading authority to defend Chapter XII-A claims on accreted/derivative securities. Retain the original FIRC / contract notes to anchor the forex 'flow-through'.

Facts

• The litigation concerned the validity of CBDT Circular No. 789 relating to the India–Mauritius DTAA and the use of a tax residency certificate to establish treaty residence.

Question(s) for determination

Whether the provisions of a DTAA prevail over the provisions of the Income-tax Act, and the scope of s. 90(2).

Decision & reasoning

The Supreme Court affirmed that, by virtue of s. 90(2), the provisions of a DTAA prevail over the Act to the extent they are more beneficial to the assessee, and that the impugned circular was valid.

Ratio decidendi

An assessee is entitled to the more beneficial of the treaty rate and the Act; s. 90(2) operates in his favour.

Application to this section

Authority for electing the lower DTAA rate in preference to the s. 115E rate where the NRI is a treaty resident, by operation of s. 90(2).

Practice note: Authority for electing a lower DTAA rate in preference to the s. 115E rate where the NRI is a resident of a treaty country (subject to TRC and Form 10F).

5. Cross-references

s. 90(2) (DTAA) • ss. 111A/112/112A (general capital-gains rates) • s. 115A (NRI interest/dividend/royalty outside the Chapter) • s. 115D (no deduction/indexation) • s. 115F (exemption) • s. 115G (return) • First Schedule to the Finance Act (surcharge & cess).

Standing Disclaimer & Verification Note