Taxation of Fixed Deposit (FD)

June 17 , 2013

Since ages fixed deposit has been an all-time favourite of investors in India. For many, investments begin and end with FDs but even the savvier ones who venture into mutual funds and shares don't dare to ignore it. So, although known to all, we thought tax aspects of fixed deposit deserve an article.

Is interest on fixed deposit tax free?

The answer is no. You need to pay income tax on whatever interest you earn out of your fixed deposit. You might have heard a lot being said about TDS on FD interest kicking in only over Rs 10,000. That is correct; TDS of 10% applies if interest from all your FDs in a bank exceeds Rs 10,000 a year.

But this does not imply that FD interest below Rs 10,000 is tax free. You need to pay tax on it by declaring the interest in ITR form while filing income tax returns and pay the tax as self assessment tax. The interest of 5 year Tax Saver FD is also taxable.

Tax rate on fixed deposit interest

Although TDS on FD interest is at 10% (20% if PAN not submitted), actually tax on fixed deposit interest is as per your tax slab. TDS is an interim tax; you need to cough up the rest as self assessment tax. For instance if you fall in the 30% tax bracket you need to pay 30% of the interest as tax deducting whatever has been adjusted through TDS. For this reason, fixed deposit is not a tax friendly investment for those in higher tax slabs, unlike debt mutual funds or other such options

Fixed deposit TDS

Some more points to remember about TDS on FDs:

1. Tax liability is determined for your account in a bank

With CBS all bank branches are linked. Most banks also have unique customer identification numbers now. If you hold FDs across different branches of the bank, interest from them all will be tallied for establishing your TDS liability.

2. TDS will apply to first holder of the account. 

In case of FD in the name of a minor child, TDS will apply on the parent. In case of a spouse's FD which was opened with money you gifted, interest income will be taxed in your hands.

Accrual basis or receipt basis?

This is another confusion among FD holders- whether tax is to be paid on accrual basis or receipt basis for fixed deposit interest. You have the choice of paying tax on interest on either method of accounting.

If your interest exceeds Rs 10,000 a year the bank would deduct TDS and this happens on accrual basis, every time it calculates interest, though you get it only on maturity. So in such a case it will be better to declare interest and pay it on a yearly basis. Moreover lump sum interest amount at maturity can raise your tax slab to the next one. If this is the case you should pay tax on interest on accrual basis. If both these concerns don't apply to you, you can afford to be a little lazy and pay tax only at maturity.

Are there ways to avoid tax on FD?

Though there aren't ways to avoid tax on interest of FD there are ways of skipping the TDS. You might wonder why anyone would look for ways to skip TDS if they have to pay tax on interest any way. The thing is, TDS applies even if your total income is below taxable limit. Such people will have to claim their money back by filing tax returns if TDS is applied on their interest.

The way out for them is to submit Form 15g to the bank while opening FD and at the start the start of every financial year till the term of FD. Senior citizens should submit Form 15h.

Others talk of avoiding TDS by breaking up the FD across various banks or timing the FD. Without getting into details of how these work, we assert that unless your income is not taxable, there is no benefit in skipping TDS.

Tax can be saved on through 80C tax benefit

This is a tax deduction used by many for saving on income tax outgo. From your income, you can invest up to Rs 1 lakh in tax saver FDs and claim that amount for deduction. Effectively your taxable income would reduce by that amount. For example if your gross income in 2013-14 is Rs 3.5 lakhs, if your deposit Rs 80,000 in tax saving FD this year your taxable income for the year becomes Rs 2.7 lakhs.

This rebate is allowed only for first account holder in case of joint account. The amount cannot be withdrawn before 5 years.

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