Oct 19, 2009

Top Most Tax Myth: Taxation of Interest on Bank FDs

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In an earlier post about bank fixed deposits (FDs), I had elaborated on the known and not-so-known facts about bank interest rates and the difference between interest rate and the yield. In continuation, this post talks about taxation of FDs Interest: the top most myth associated with Bank Fixed Deposits (FDs).

A lot many people believe that tax on Bank FD interest is payable only at the time of maturity; others think that it has to be taxed on accrual / annual basis. Then there is another associated myth that if TDS is already deducted on interest income from Bank FDs, then it need not be shown in return of income (ITR). Therefore, this post is going to dig out the facts concerning taxation of interest income on bank FDs including the tax deduction at source (TDS).

Note: The ensuing discussion is regarding tax implications of interest income on bank fixed deposits of resident Indians. In other words, taxation (including TDS) of NRO (Non-resident ordinary rupee account) deposits of NRIs (Non-resident Indians) is not covered and will be discussed separately in another post.

Taxation of Interest on Bank FDs
Know that interest income from Bank fixed deposits (FDs) is fully taxable in your hands. It is included in your other income and taxed according to applicable highest tax bracket.

Interest Income on FDs: Taxation vs. TDS
Understand that TDS and taxability of interest are two separate things.

First, just because TDS has been deducted from interest income on bank FD doesn’t mean that you’re no more required to show it in your return of income.

Second, even if there is no tax deduction at source (TDS), you’ve to include the interest income in your total taxable income and pay tax on it at the maximum marginal rate applicable to you.

Regarding TDS, two points are worth noting. First, TDS on bank interest is always deducted @ 10% whereas the marginal rate of tax applicable to you may be 20% or 30%; therefore, there can be additional tax liability based on your total income. Second, even if full TDS gets deducted from any income, one has to show both the income earned as well as TDS deducted in the return of income (ITR).

However, according to section 145 of the IT Act, 1961, you’re provided an option to include the interest income for tax purposes either on cash / receipt basis or accrual basis as per the regular method of accounting employed by you. But, once a choice is made, it should be followed consistently.

Anyhow, it is better to show the interest income on accrual / annual basis because you might have to pay higher tax if you show the entire interest on FD in the year of maturity due to increase of income to next higher tax bracket.


Rate of TDS on Bank FDs
As per section 194A of IT Act, 1961, tax @ 10% (earlier 10.30%) is deducted at source if the aggregate interest payable or reinvested exceeds Rs 10,000 for all your deposits (except recurring deposits and savings account deposit) in a bank branch during a financial year. TDS is deducted every time bank pays interest during the financial year. It is also deducted on interest accrued (but not paid / credited) at the end of every financial year (i.e., 31st March).

As per the changes made by budget 2009, with effect from April 1, 2010, it is compulsory for you to furnish your PAN to the Bank failing which the bank will deduct TDS at the rate of 20% instead of 10%.


Avoiding TDS on Bank FDs: Form G / Form H
If your income is below the taxable limit, you need to present Form 15G/15H (as per section 197A of Income Tax Act, 1961), while opening a Fixed Deposit (FD) account in a bank to avoid tax deduction at source (TDS) from your interest income. Following points are worth noting regarding self-declaration in Form 15G / 15H:
1. While Form 15H is meant for senior citizens (Earlier age 65 years, now from FY 2011-12 reduced to 60years), 15G is for any other individual.

2. Form 15G / Form 15H can be submitted only if the tax on your total income is nil. In other words, you can’t submit a Form 15G / 15H if you’re already a tax payer.

3. New Form 15G / Form 15H has to be submitted for each FY.

4. An individual who is liable to pay tax can apply in Form 13 to Assessing Officer (as per Section 197) to obtain a certificate of lower rate of tax or no tax as may be appropriate.

5. According to amendment made by Finance Act 2009, the requirement of submission of PAN is also made mandatory for those submitting declaration in Form No 15G / Form 15H (effective from April 1, 2010). In other words, in the absence of PAN, the Form 15G / Form 15H declaration would become invalid.

I hope this answers all your questions regarding TDS and taxation of interest on bank fixed deposits. If any doubts remain, ask in the comment box.

The next part will discuss about other considerations to know while investing in Bank FDs.


Also see:


1. Bank FDs - Interesting Interest Information
2. Investing in Bank FDs - 3 Other Considerations
3. Impact on Continuity of an FD in case of Death

2 comments:

  1. "It is also deducted on interest accrued (but not paid / credited) at the end of every financial year (i.e., 31st March)."

    Fisher, are you sure ? I have term deposits with banks but they deduct tax only if it exceeds 10,000 at the time of maturity.

    ReplyDelete
  2. Yes, I’m sure about it. Your case appears to be an exception rather than the norm.

    There might be more such instances but this practice is not in accordance with tax law because section 194A makes it mandatory to deduct TDS on accrual basis.

    ReplyDelete

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