Singapore tax clarification clouds returns from leveraged FCNR deposits: Report

India's special Foreign Currency Non-Resident (Bank) [FCNR(B)] deposit scheme has attracted strong interest from non-resident Indians (NRIs), but a clarification from Singapore's tax authority has raised fresh concerns for investors using leveraged structures to maximise returns.

For the past two weeks, NRIs in Singapore, private bankers and wealth managers have debated whether interest on loans taken from Indian banks to invest in FCNR deposits would attract withholding tax (WHT). The uncertainty prompted concerns that an additional tax burden could significantly reduce the returns offered under these schemes.

According to a report by the Economic Times, the Inland Revenue Authority of Singapore (IRAS) has now clarified that interest paid by a Singapore tax resident on a loan from an Indian bank is deemed to be sourced from Singapore under the country's Income Tax Act and is therefore subject to withholding tax.

Under the India-Singapore Double Taxation Avoidance Agreement (DTAA), the applicable withholding tax is generally 10% of the gross interest amount, subject to treaty conditions. However, IRAS said the tax would not apply if the payment is made to the Singapore branch of an Indian bank.

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The clarification is particularly relevant for leveraged FCNR products, where investors borrow between nine and nineteen times their initial capital and place the combined amount in FCNR deposits. Since the spread between borrowing costs and deposit returns is relatively narrow, the additional withholding tax could substantially reduce gains and, in some cases, even result in negative returns.

Tax experts said withholding tax applies even when loan interest is adjusted against deposit earnings instead of being paid separately. They also cautioned that non-compliance could attract penalties of 20% in addition to the withholding tax payable, making tax planning crucial for investors using these structures.

FCNR(B) inflows

Despite the tax-related concerns, FCNR(B) deposits continue to witness robust mobilisation. According to SBI Research, inflows have already crossed $26 billion, exceeding the amount raised under the Reserve Bank of India's landmark 2013 FCNR(B) scheme in just 45 days. RBI had earlier reported total inflows of $20.7 billion up to July 17, including $17.4 billion through FCNR(B) deposits.

SBI Research has raised its estimate for FCNR(B) mobilisation to $65-70 billion by the time the RBI's special deposit window closes, up sharply 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.

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The report said public sector banks are likely to account for a significant share of the mobilisation. It also expects many FCNR(B) deposits maturing in August and September to be renewed at higher interest rates, with renewals alone contributing nearly $10 billion.

SBI Research believes the inflows could transform India's external position, projecting the balance of payments to swing to a surplus of over $50 billion in FY27, compared with its earlier estimate of a $65-70 billion deficit. The current account deficit is forecast at 1-1.2% of GDP. However, the report cautioned that the rupee remains under pressure and suggested the Reserve Bank may need to step up intervention in the foreign exchange market to stabilise the currency.