Section 89(1) relief on arrears: Form 10E filing for NRI-to-resident transition years

When a Non-Resident Indian returns home, the first Indian financial year of the move is rarely tidy. Pension that accrued during 2022-24 lands as a single lump sum in 2025-26; an Indian employer settles 18 months of deferred salary on the joining date; a leave-encashment cheque from a former Gulf posting is remitted after the calendar has turned. Each of these is taxable in the year of receipt, and because the Indian rate schedule is progressive, bunching three years of income into one assessment year can push a returning NRI into the 30% bracket that begins at Rs 24,00,000 under the FY 2025-26 new regime. Section 89(1) of the Income-tax Act 1961, read with Rule 21A, exists precisely to undo that distortion, and Form 10E is the gatekeeper: file it online before the return, or the relief is denied at processing under Section 143(1).

This guide walks through the statute, the Rule 21A arithmetic, the interaction with foreign tax credit for those still filing in the United States or the United Kingdom, and the FEMA repatriation mechanics that govern how arrears credited to an NRO account actually move abroad. Every figure below is drawn from the Income-tax Act, RBI master directions, or the FY 2025-26 slab schedule notified for assessment year 2026-27.

FEMA / DTAA Position

The transition year is governed first by residential status, which FEMA and the Income-tax Act define differently and which must both be tracked. Under Section 6 of the Income-tax Act 1961, a returning individual who has been a non-resident in 9 of the 10 preceding previous years, or who was physically in India for 729 days or fewer in the 7 preceding years, qualifies as Resident but Not Ordinarily Resident (RNOR) for up to three assessment years. During RNOR status, foreign-source income stays outside the Indian net while Indian-source receipts — including India pension arrears and salary paid in India — are fully taxable. Determining where you sit is the starting point; our residential status glossary sets out the day-count tests in full, and the NRI income-tax calculator applies the FY 2025-26 brackets to a transition-year income mix.

FEMA Section 6 of the Foreign Exchange Management Act 1999 separately requires RBI permission for capital-account transactions unless they are specifically permitted, and pegs the resident Liberalised Remittance Scheme limit at USD 250,000 per financial year. On return, a person who becomes a resident under FEMA must redesignate existing Non-Resident External (NRE) and FCNR accounts; balances may be transferred to a Resident Foreign Currency (RFC) account under the RBI master direction on deposits, preserving foreign-currency denomination without breaching residency rules. The statutory text of both Acts is published at indiacode.nic.in and should be the reference of record before any filing.

On the treaty side, Section 89(1) relief is a purely domestic mechanism — it does not depend on any Double Taxation Avoidance Agreement. But for a returning NRI who remains a US tax resident in the overlap year, the India-USA DTAA still matters for the income that triggered the arrears. Under the treaty, India retains taxing rights on most India-sourced income: long-term capital gains are taxable at 12.5%, dividends at 15% for portfolio holdings, and interest at 15%, with foreign tax credit available in the country of residence under Article 24. The DTAA concept page explains how source and residence rights are split; crucially, capital gains are never simply "exempt" under the treaty — India keeps the right to tax them at 12.5%.

Tax Treatment in India

Section 89(1) applies where salary, or arrears or advance of salary, family pension arrears, gratuity, leave encashment, or commuted pension are received in a previous year that relates to an earlier year, and the tax burden in the year of receipt is higher than it would have been had the income been taxed in the year of accrual. Rule 21A prescribes the computation, and the relief is the excess of the receipt-year incremental tax over the accrual-year incremental tax. The relief is available under both the old regime and the new regime introduced by Section 115BAC, so a returning NRI does not forfeit it by defaulting into the new structure for FY 2025-26.

The receipts that qualify under Rule 21A are specific, and anything outside the list cannot be smoothed:

The mechanics follow a five-step comparison. First, compute the tax on the receipt-year total income including the arrears. Second, compute the tax on the receipt-year total income excluding the arrears; the difference is the additional tax the bunching creates. Third and fourth, add the arrears to the total income of each earlier year to which they relate and compute the additional tax those years would have borne at the rates then in force. The relief under Section 89(1) is the first difference minus the second. Because earlier-year tax must be computed at that year's Finance Act rates, the accrual-year leg should always be checked against the rate schedule notified for the relevant assessment year on incometax.gov.in.

To see why the relief is worth claiming, consider the FY 2025-26 rate schedule that governs the receipt-year leg:

Under the new regime, the Section 87A rebate now extends to a total income of Rs 12,00,000 with a maximum rebate of Rs 60,000, against the old-regime threshold of Rs 5,00,000 and a Rs 12,500 cap. A returning NRI whose normal annual income sits just below the rebate ceiling can be tipped into a taxable bracket purely by three years of bunched pension; Section 89(1) restores the position as though each slice had been taxed in its own year. A health and education cess of 4% applies on top of the computed tax in every case, and surcharge — 10% above Rs 50,00,000, rising in steps but capped at 25% in the new regime — is computed on the relieved figure. The surcharge glossary and the TDS reference explain how the deductor treats lump-sum arrears before any relief is applied.

A practical trap sits in the sequencing. Form 10E must be filed online through the e-filing portal before the income-tax return for the year in which the arrears are received. If the return claims Section 89(1) relief but Form 10E is not on record, the Centralised Processing Centre disallows the relief in the Section 143(1) intimation and raises a demand for the tax plus interest under Section 234. There is no penalty for late filing of Form 10E itself, but the relief cannot be claimed in the return until the form is submitted, so the order of operations is non-negotiable.

Tax Treatment Abroad

For a returning NRI who is still a US person in the transition year — common where a Green Card holder relocates mid-year — the same India pension arrears may also appear on a US Form 1040, because US citizens and residents are taxed on worldwide income. The India-USA DTAA, effective from 12 September 1991, resolves the overlap through Article 24, which obliges the residence country to grant a credit for taxes paid in the source country. India taxes the pension as source income; the United States then allows a foreign tax credit on Form 1116 for the Indian tax actually paid, subject to its own limitation rules.

The interaction with Section 89(1) is subtle and worth stating precisely: the relief reduces the Indian tax payable, which in turn reduces the foreign tax credit the taxpayer can claim abroad, because only tax actually paid in India is creditable. A returning NRI should therefore model both legs together rather than maximising one in isolation; the foreign tax credit calculator and our standing explainer on the India-USA DTAA Article 25 foreign tax credit mechanism set out the Form 67 filing that India requires to claim relief in the reverse direction.

One frequent error is to assume the pension is exempt abroad because it was taxed in India. It is not exempt; it is relieved through a credit, and the credit is capped at the foreign jurisdiction's own rate on that income. Where the Indian effective rate after Section 89(1) relief falls below the US rate, residual US tax remains payable on the difference, computed on the gross arrears in the year the US recognises the income.

Repatriation Mechanics

Arrears of India pension and India-paid salary are credited to a Non-Resident Ordinary (NRO) account, because they are Indian-source income. The NRO account is the correct destination during the period the individual is still classified as non-resident under FEMA; current income such as pension is freely repatriable, while accumulated balances are repatriable up to USD 1,000,000 per financial year under the RBI scheme, on production of Form 15CA and a chartered accountant's Form 15CB certifying that applicable tax has been paid. The NRO account glossary and the repatriation calculator help size the post-tax amount available to move abroad in a given year.

Funds in Non-Resident External (NRE) and FCNR accounts are, by contrast, fully and freely repatriable with no annual ceiling, because they represent foreign earnings already remitted into India. The distinction matters in the transition year: pension arrears cannot be parked in an NRE account, which only accepts foreign-currency inward remittances, so the USD 1,000,000 NRO cap is the binding constraint on moving smoothed pension income out of India. The NRE account and FCNR deposit pages set out the eligibility rules in detail.

Once the individual becomes a resident under FEMA — which can happen within the same financial year as the return — the NRE and FCNR accounts must be redesignated. Balances may be moved to a Resident Foreign Currency (RFC) account, which retains foreign-currency denomination and remains freely repatriable should the person leave India again, under the RBI master direction on deposits published at rbi.org.in. The NRO account is redesignated as a resident savings account on the change of status. Form 15CA and Form 15CB, filed through the e-filing portal, remain mandatory for any remittance out of India exceeding the prescribed threshold, regardless of whether Section 89(1) relief has reduced the underlying tax.

A returning NRI should sequence the year deliberately: confirm RNOR status under Section 6, ensure the deductor has applied TDS on the gross arrears, file Form 10E before the return to capture Section 89(1) relief, then plan the NRO repatriation within the USD 1,000,000 annual window with Forms 15CA and 15CB. Each step is documented and time-bound, and skipping the Form 10E step is the single most common reason relief is lost at processing.

FAQ

Can I claim Section 89(1) relief if I file under the new tax regime for FY 2025-26?

Yes. Section 89(1) relief is available under both the old regime and the new regime under Section 115BAC, and the briefing position is explicit that the relief survives the regime choice. The receipt-year tax is computed using the FY 2025-26 slabs you have opted into, and the accrual-year tax at the rates in force in each earlier year. Note separately that the 80CCD(1B) NPS deduction of Rs 50,000 is NOT allowed in the new regime and can only be claimed under the old regime, so do not confuse regime-specific deductions with the regime-neutral Section 89(1) relief.

What happens if I file my return claiming relief but forget Form 10E?

The Centralised Processing Centre disallows the Section 89(1) relief in the Section 143(1) intimation and raises a demand for the additional tax, with interest under Section 234. There is no separate penalty for filing Form 10E late, but the relief cannot be granted until the form is on record, so file it online before submitting the return for the year of receipt, as required on incometax.gov.in.

Does Section 89(1) apply to gratuity received on my return to India?

Gratuity first enjoys the Section 10(10) exemption — up to Rs 20,00,000 for non-government employees, a cap raised from Rs 10,00,000 by the Finance Act 2018, and full exemption for government employees. Only the taxable portion above that exemption can attract Section 89(1) relief, and Rule 21A(3) prescribes a distinct method depending on whether past service was 5 to 15 years or 15 years and above.

My pension arrears were also taxed in the United States. Do I pay tax twice?

No, but they are not exempt either. India taxes the pension as source income, and under Article 24 of the India-USA DTAA, effective 12 September 1991, the United States grants a foreign tax credit on Form 1116 for the Indian tax actually paid. Because Section 89(1) reduces the Indian tax, it also reduces the creditable amount, so model both legs together rather than in isolation.

How much of my smoothed pension can I repatriate in a year?

Current pension income credited to an NRO account is freely repatriable, and accumulated NRO balances are repatriable up to USD 1,000,000 per financial year under the RBI scheme, on submission of Form 15CA and a chartered accountant's Form 15CB. NRE and FCNR balances carry no repatriation ceiling because they hold already-remitted foreign earnings.

Do I need to recompute relief for each earlier year the arrears relate to?

Yes. Rule 21A requires the arrears to be allocated to each earlier year to which they relate, and the additional tax of each such year computed at that year's rates, before the relief is aggregated. Always verify the accrual-year Finance Act rates against the schedule for the relevant assessment year on incometax.gov.in before finalising the Form 10E figures.

Does Section 89(1) relief affect the surcharge and cess on my return?

Yes. The relief reduces the base tax, and surcharge — 10% above Rs 50,00,000, capped at 25% in the new regime — together with the 4% health and education cess is computed on the post-relief figure. This is why claiming the relief through Form 10E can lower the headline liability by more than the slab effect alone.