Non-resident Indian (NRI) investors using leveraged Foreign Currency Non-Resident (Bank) [FCNR(B)] deposit structures are facing new uncertainties regarding their returns, following a clarification from Singapore's tax authority. The Inland Revenue Authority of Singapore (IRAS) has stated that interest paid by a Singapore tax resident on a loan from an Indian bank to fund these deposits is subject to withholding tax.
Withholding Tax Implications for NRIs
The clarification from IRAS specifies that interest on loans taken from Indian banks to invest in FCNR deposits is deemed to be sourced from Singapore under the country's Income Tax Act, thus making it subject to withholding tax (WHT). Under the existing India-Singapore Double Taxation Avoidance Agreement (DTAA), the applicable WHT is generally 10% of the gross interest amount, provided treaty conditions are met. However, IRAS noted that this tax would not apply if the loan payment is made to the Singapore branch of an Indian bank.
This development is particularly critical for leveraged FCNR products, where investors typically borrow substantial amounts—between nine and nineteen times their initial capital—to maximize their FCNR deposit placements. Given the often narrow spread between borrowing costs and deposit returns, the imposition of an additional withholding tax could significantly erode potential gains, potentially leading to negative returns in some scenarios.
Penalties and Compliance
Tax experts caution that the withholding tax applies even when loan interest is offset against deposit earnings, rather than being paid as a separate transaction. Non-compliance with these new tax requirements could result in penalties of 20% in addition to the payable withholding tax, underscoring the critical need for meticulous tax planning among investors utilizing these leveraged structures.
FCNR(B) Deposits Continue Robust Inflows
Despite these emerging tax concerns, FCNR(B) deposits continue to attract strong interest. According to SBI Research, inflows have already surpassed $26 billion, exceeding the total amount raised under the Reserve Bank of India's landmark 2013 FCNR(B) scheme in just 45 days. The RBI had previously reported total inflows of $20.7 billion up to July 17, with $17.4 billion specifically from FCNR(B) deposits.
SBI Research has revised its forecast for FCNR(B) mobilization to $65-70 billion by the time the RBI's special deposit window closes, a sharp increase from its earlier projection of $40-45 billion. Including Overseas Foreign Currency Borrowings (OFCBs) and External Commercial Borrowings (ECBs), total foreign currency inflows are expected to reach $80-85 billion. Public sector banks are anticipated to account for a significant portion of this mobilization. Additionally, many FCNR(B) deposits maturing in August and September are expected to be renewed at higher interest rates, with renewals projected to contribute nearly $10 billion.
These substantial inflows are expected to significantly bolster India's external financial position. SBI Research projects India's balance of payments to swing into a surplus of over $50 billion in FY27, a stark contrast to its previous estimate of a $65-70 billion deficit. The current account deficit is now forecast at 1-1.2% of GDP. However, the report also highlights ongoing pressure on the rupee, suggesting the Reserve Bank may need to increase intervention in the foreign exchange market to stabilize the currency.