Taxed or Tax-Free? How Interest on NRE vs NRO Accounts Is Treated, and Where a DTAA Helps

Two deposits of Rs 50,00,000 each, placed with the same Indian bank on the same day at the same contracted rate of 7.00 per cent, will not pay the same amount into your hands. Put one in a Non-Resident External account and the annual interest of Rs 3,50,000 reaches you whole. Put the other in a Non-Resident Ordinary account and the bank must withhold before it credits a rupee, leaving roughly Rs 2,40,800 after a 31.20 per cent deduction. The deposit is identical. The account label is what moves the money.

That difference is not bank policy and it is not negotiable at a branch counter. It is written into the Income-tax Act 1961 and reinforced by the Reserve Bank of India's guidance on accounts held in India by non-residents, which states that interest earned on NRE and FCNR(B) accounts is exempt from Indian income tax, whereas interest on an NRO account is taxable in India and subject to tax deduction at source. Where the holder is resident in a country with which India has a Double Taxation Avoidance Agreement, a lower treaty rate may apply on the NRO interest, depending on the treaty and the residency documentation furnished.

FEMA / DTAA Position

The exchange control layer comes first, because the account type is a FEMA construct before it is a tax construct. Under the Foreign Exchange Management Act 1999, a person resident outside India may maintain an NRE account, an FCNR(B) deposit and an NRO account, each fed by a different class of money. NRE holds funds remitted from outside India and converted into rupees on credit; FCNR(B) holds the same remitted funds but keeps the foreign currency denomination, removing rupee conversion risk over the deposit term. An NRO account holds India-sourced receipts: rent, dividends, pension, proceeds of an asset sold in India, and balances redesignated when a resident account holder leaves India.

The tax exemption follows the FEMA status, not the other way round. The exemptions for NRE interest under Section 10(4)(ii) and for FCNR(B) interest under Section 10(15)(iv)(fa) of the Income-tax Act 1961 are available only while the holder is a person resident outside India within the meaning of FEMA 1999. The moment that ceases to be true, the exemption ceases with it. This is the most expensive point of confusion in the whole area, and it is why a returning non-resident must redesignate accounts promptly rather than let an NRE fixed deposit run on to maturity under a status that no longer exists. We set out that conversion separately in our note on how Indian bank accounts convert when residential status changes.

The treaty layer sits on top and does one thing for interest: it caps the rate at which India, as the source country, may tax. Section 195 of the Income-tax Act 1961 requires withholding under the DTAA rate or the rate in the Act, whichever is lower. That single sentence is the entire architecture. India's domestic rate on NRO interest is 30 per cent; a treaty capping interest at 15 per cent displaces it, and one capping it at 12.5 per cent displaces it further. No treaty raises the Indian rate above the domestic one, so the comparison only ever runs in the taxpayer's favour.

One point of discipline, because it is where much bad advice originates: a DTAA does not make Indian income tax-free, it allocates and it caps. The capital gains articles in India's agreements with the United States, the United Kingdom, the United Arab Emirates, Singapore, Canada and Australia all preserve India's taxing rights rather than exempting the gain. Treat any claim that a treaty makes an Indian receipt wholly exempt as one needing a specific article reference before you act on it.

Tax Treatment in India

NRE and FCNR(B) interest attracts no Indian income tax and therefore no TDS. The bank credits the gross amount and nothing is reported against those accounts. NRO interest is the opposite in every respect.

The domestic deduction on NRO interest is 30 per cent under Section 195, and 30 per cent is not the number that leaves your account. The rate is increased by the applicable surcharge and then by health and education cess at 4 per cent of tax plus surcharge. Where no surcharge tier is triggered, the effective deduction is 31.20 per cent. The tiers above it compound quickly.

Two features deserve emphasis. First, the surcharge ladder in the new regime is capped at 25 per cent, so 39.00 per cent is the ceiling for NRO interest and no higher figure should appear on a deduction advice. Second, the deduction is on gross interest, with no threshold and no basic exemption at source. A resident depositor enjoys a Rs 40,000 TDS threshold under Section 194A and a 10 per cent rate; a non-resident has neither. On Rs 1,00,000 of NRO interest a resident sees nothing withheld and a non-resident sees Rs 31,200.

That mismatch is the practical problem. TDS at 31.20 per cent is a withholding, not a final tax: a non-resident whose Indian income sits inside the basic exemption limit has a liability of nil and a deducted amount of Rs 31,200, recoverable only by filing a return. Our NRI tax calculator runs that comparison on your own figures, and the DTAA benefit calculator shows the gap between 30 per cent and a treaty rate.

Where a treaty applies, the deduction should be made at the treaty rate at source rather than at 31.20 per cent with a refund to follow. Three documents must be with the bank before the interest is credited, and banks apply the full domestic rate when any one is missing. A valid Tax Residency Certificate from the tax authority of the country of residence is the first, typically valid for 12 months, so it must be re-lodged each year rather than filed once. Form 10F is the second, filed electronically on the Income Tax Department portal and carrying the TRC particulars, so a paper form handed across a counter no longer suffices. A PAN is the third, and its absence is punitive: a payee without PAN loses the lower rate the treaty would otherwise deliver. A no-permanent-establishment declaration is normally required alongside.

The treaty interest rates for the six most common host countries are set out below, with the date each agreement took effect.

On Rs 5,00,000 of annual NRO interest the domestic deduction at 31.20 per cent is Rs 1,56,000. At the India-United States treaty rate of 15 per cent it is Rs 75,000, and at the India-UAE rate of 12.5 per cent, Rs 62,500. The paperwork is therefore worth between Rs 81,000 and Rs 93,500 a year on that one deposit.

Tax Treatment Abroad

The Indian exemption on NRE and FCNR(B) interest is an Indian exemption and nothing more. It does not bind the country you live in. A United States resident is taxed on worldwide income and must report NRE interest on the US return notwithstanding that India charged nothing, and because India levied no tax there is no Indian tax to credit under Article 24 of the 1991 agreement. A deposit that is tax-free in Indian hands can be fully taxable in American, British, Canadian or Australian hands at the resident marginal rate.

NRO interest behaves differently abroad precisely because India has taxed it. The credit method in Article 23 of the India-Australia agreement, and the equivalent provisions in the other five treaties above, allow Indian tax to be set against the liability in the country of residence, so the total burden converges on the higher of the two effective rates rather than stacking. Canada operates this through Section 126 of its Income Tax Act. The credit is normally limited to the treaty rate, a second reason to lodge the TRC and Form 10F in time: a foreign authority may decline to credit Indian tax deducted above the treaty cap, on the view that the excess was recoverable from India by refund.

The United Arab Emirates is the mirror image. With no personal income tax on individual interest income, a UAE-resident depositor with an NRE account pays nothing in either jurisdiction, and on an NRO account the 12.5 per cent treaty rate under the 1993 agreement is a final cost with nothing abroad to credit it against. That asymmetry, not any Indian rule, is why the choice is felt more sharply in the Gulf than in London or Toronto.

Repatriation Mechanics

Tax treatment and repatriability are separate questions that are habitually conflated. NRE and FCNR(B) balances, funded by inward remittance, are freely repatriable in both principal and interest without limit. NRO balances are not, and they sit inside the FEMA ceiling of USD 1 million per financial year covering the aggregate of NRO balances, asset sale proceeds and inherited property, a route we set out in detail in our note on the USD 1 million a year FEMA route.

The distinction that saves the most money is between NRO principal and NRO income. Where funds reaching the NRO account have already borne tax, there is no further deduction at the point of transfer, and current income of the kind covered in our note on rent, dividends and pension moves on its own footing. An NRO to NRE transfer requires Form 15CA and Form 15CB; the repatriation calculator computes the net figure, as does the rental income tax calculator where the credit is rent rather than interest.

One habit is worth adopting. Because the bank applies 31.20 per cent by default and the treaty rate only on documentation, lodge the TRC and Form 10F in April, at the start of the financial year, rather than when the first interest credit falls due. A deduction already made at the domestic rate cannot be reversed by the branch; it can only be recovered by filing an Indian return. If a bank holds complete and valid documentation and still applies the domestic rate, that is a banking service grievance: raise it in writing with the bank, and thereafter through the Reserve Bank's complaint management system at cms.rbi.org.in.

Finally, check Form 26AS before filing. Every rupee deducted under Section 195 should appear there against your PAN, and where it does not, the credit cannot be claimed however clear the bank's advice may be. Reconciling the two in June, before the return is prepared, is a fifteen-minute exercise that repeatedly prevents a refund being held up for a full assessment cycle.

FAQ

Is interest on an NRE fixed deposit completely tax-free in India?

Yes, while the holder remains a person resident outside India under FEMA 1999. The exemption under Section 10(4)(ii) of the Income-tax Act 1961 covers the interest in full, no TDS is deducted, and the bank credits the gross amount. The exemption is tied to residential status, not to the account staying open, so it falls away the moment the holder becomes a resident even if the deposit runs on to maturity.

What rate of TDS applies to NRO interest?

Thirty per cent under Section 195 of the Income-tax Act 1961, increased by the applicable surcharge and by health and education cess at 4 per cent. Where no surcharge applies the effective deduction is 31.20 per cent, rising to 34.32 per cent at the 10 per cent surcharge tier and 35.88 per cent at the 15 per cent tier. There is no threshold below which the deduction is not made.

Can a DTAA reduce the deduction on my NRO interest?

It can. Section 195 requires withholding at the DTAA rate or the rate in the Act, whichever is lower, so a treaty interest cap of 15 per cent displaces the domestic 30 per cent. The India-UAE agreement of 22 September 1993 caps interest at 12.5 per cent, and the agreements with the United States, the United Kingdom, Singapore, Canada and Australia each cap it at 15 per cent. The rate is treaty-specific and depends on documentation being in place.

What documents does the bank need before applying the treaty rate?

A valid Tax Residency Certificate from the tax authority of your country of residence, Form 10F filed electronically on the Income Tax Department portal, and a PAN. A no-permanent-establishment declaration is commonly required in addition. TRCs are typically valid for 12 months and must be re-lodged annually; if any document is missing or expired, the bank applies the full domestic rate.

If tax was deducted at 31.20 per cent, can I get it back?

Yes, by filing an Indian income tax return and claiming the excess as a refund. TDS under Section 195 is a withholding, not a final tax, so where your actual liability is lower than the amount deducted the difference is refundable. Verify first that the deduction appears in Form 26AS against your PAN, because credit cannot be claimed for an amount not reported there.

Does the Indian exemption on NRE interest mean it is tax-free everywhere?

No. The exemption is an Indian one only. A resident of the United States, the United Kingdom, Canada or Australia is taxed on worldwide income and must report NRE interest at home, and because India charged nothing there is no Indian tax to credit against that liability. A UAE resident faces no personal income tax on it.

Is NRO interest freely repatriable once tax has been deducted?

Not without limit. NRE and FCNR(B) balances are freely repatriable in principal and interest, while NRO balances fall inside the FEMA ceiling of USD 1 million per financial year covering NRO balances, asset sale proceeds and inherited funds together. A transfer out requires Form 15CA and Form 15CB, and funds that already bore tax before reaching the NRO account attract no further deduction.