Investors now have another avenue to park their money in for the medium term and book tax benefits, besides the good old small savings schemes. If they park up to Rs 1 lakh in term or fixed deposits of commercial banks for five years or more, they will be eligible to deduct the amount from their taxable income.

This will place fixed deposits on par with schemes unveiled by the government such as the National Savings Certificate (NSC) and the Public Provident Fund in terms of offering tax breaks. In its edition dated July 25, ET had reported that the government will soon allow tax sops on bank deposits. The tax break on fixed deposits was spelt out by the finance ministry in a notification issued on Monday evening. The move is expected to help banks in building up a stable deposit base, and even lower their cost of fund. In the last monetary policy, RBI pointed out that banks should try to build a durable, retail deposit.

Unlike the schemes with administered interest rates, banks will have pricing freedom. But they can no longer sell term products as one with the flexibility of withdrawals before maturity.

As in the case of these small savings schemes, investors placing money in term deposits and planning to take a tax deduction will have to reconcile to a lock-in period of five years. The government notification says that no term deposit can be encashed before five years from the date of investment. The ceiling on investment is Rs 1 lakh.

The interest earned on these deposits will attract tax either on an accrual basis or on receipt basis.

If the deposit is made with a joint holder, then the tax benefit will be available only to the first holder. A host of banks, who were waiting for the notification, are now expected to unveil new term deposit products to attract investors.

In FY06, the government permitted investments of up to Rs 1 lakh in designated investments like PPF, NSC, repayment of the principal on housing loans and payment of education fees to be deducted from the taxable income under Sec 80 C of the Income Tax Act. However, early this year, banks managed to lobby successfully to include term deposits in this list of eligible investments.