Faced with a bank deposit growth rate of 18% even as credit offtake has grown 30% over the year, the finance ministry is considering tax sops on deposits. The banking division is favourably disposed towards the industrys demands to make bank deposits more attractive. Specifically, it is looking at exempting interest on long term deposits up to Rs 15,000, exempting interest income on savings bank deposits from income tax, and increasing the TDS ceiling on fixed deposits to Rs 10,000 from Rs 5,000.

Interest on bank deposits used to be allowed as a deduction, subject to a ceiling of Rs 12,000 per annum under section 80L of the Income Tax Act. The exemption was withdrawn in the Finance Act, 2005. The Indian Banks Association has recommended restoration of that exemption and at a higher ceiling of Rs 15,000. Reintroduction of 80L can be considered to make bank deposits attractive, a government source said.

We want banks to build on low-cost deposits. One way to encourage this would be to consider exempting the interest income from these deposits from the purview of income tax. This will make savings bank deposits an attractive option for the public, the source said.

Savings bank deposits constitute a major portion of bank deposits in rural areas. As per the RBI directive, such deposits earn 3.5% interest which is subject to income tax. With the current inflation level over 5%, the real return from these deposits is negative. Banks want to shed bulk deposits and acquire low-cost deposits, the source said. Further, the small amounts of interest accruing on savings account deposits are difficult to keep track of for a host of individual taxpayers. Exempting interest income on small deposits would remove this irritant too.

The government is planning to bring down the lock-in for tax breaks on fixed deposits to three years from the current five years. The Centre is also considering raising the ceiling for tax deduction at source (TDS) on interest income from fixed deposits in public sector banks to Rs 10,000.

Under current guidelines, banks have to deduct TDS on the interest paid to depositors if it is more than Rs 5,000 in a given financial year.

The credit to GDP ratio is only 40%, compared to 156% in the US. Therefore, credit growth flow will remain unabated. Last year, the incremental credit deposit ratio was 100%. In order to keep asset-liability mismatches at bay, deposit growth has to be stronger, a government official said. After meeting statutory requirements, on account of 25% SLR and 5.5% CRR, banks are left with 69.5% of funds that can be deployed.

While the revenue department may not favour restoring tax exemptions, the government has to balance such norms of propriety with the economys growth requirements.