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Figure out the tax angle on your fixed deposits
December, 14th 2006

Banks attract customers to fixed deposits to meet their own increasing credit demand. Arnav Pandya explains the taxes applicable on FDs

Bank fixed deposits (FDs) have been the centre of attention for quite some time now. Prior to the last budget, there was a demand to include bank deposits in the list of eligible instruments under Section 80C of the Income-Tax Act for claiming tax benefits. This proposal was accepted and a five-year bank deposits were made eligible securities. Several banks have since launched their offerings.

However, this has not made things easier for banks, which have found that rapid credit growth requires large amounts of deposits. Hence, they are making a lot of effort to acquire more deposits. Many individuals are confused about basic taxation relating to bank FDs. Heres how investors can tackle this issue.

Taxing FDs: Two aspects

There are two aspects related to taxation of bank FDs. The first is overall taxation of the income generated from bank FDs. The income received in the form of interest is taxed. The second aspect is the tax deduction at source (TDS) that takes place when interest is earned on deposits. Both these issues have different guidelines and it is necessary to consider both of them for taxation of interest on bank FDs.

Taxation of interest

The first point to consider is the actual taxation of interest earned on bank FDs. According to the current guidelines for interest earned on bank FDs, the amount is taxable in the hands of the receiver. No deduction is allowed from the amount earned as interest from bank FDs. Till some time back, Section 80L in the I-T Act allowed a deduction up to Rs 12,000 on such deposits. With the elimination of this deduction, every rupee earned on the deposit will be taxed.

Interest generated from bank FDs falls under the head income from other sources. This is part of the total income of the individual and hence, is taxed at the normal applicable rate, depending on the tax slab that a person falls under.

There are two ways in which interest is received. The first is where interest is paid out to the investor at regular intervals. Here, taxation is not an issue because the moment the interest is due and is paid out, it is taxed in the hands of the receiver.

The next case is where the interest is accumulated and paid out at the time of maturity. In such a situation, the investor has to consider the accrued interest for each year, which is taxed for that year.

Tax deduction at source

Another aspect that needs to be considered is the TDS on interest received from bank fixed deposits. TDS implies that a part of the income is deducted and paid to the government at the time of paying the amount to the investor. Due to this, the investor receives a lower sum than the actual calculation.

According to the current guidelines, a bank deducts TDS for an investor when the interest exceeds Rs 5,000. TDS is not an issue when an individual needs to pay tax on his income. But the problem arises when no tax needs to be paid on income and yet, TDS is present. This may happen in the case of senior citizens and they will then have to wait till its time to file returns to get back the amount as a refund.

Read the fine print

Investors must understand that just because a deposit is subject to TDS when the interest is paid out, it does not mean that no further tax needs to be paid. The TDS is at a specified rate while the actual tax rate applicable on the income may be higher and thus, there may be additional tax liability.

This process can be tackled by considering the total income earned. Once this is done, the actual tax payable can be known. From this amount, the TDS has to be reduced to arrive at the requisite figure. There can either be an additional tax on the income, or there can be a refund that will be due to the investor.

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