The tax department has increased scrutiny of fixed deposits. According to news reports, individuals who earn from fixed deposits but do not pay tax or file their tax returns are under the taxman’s radar. And for good reason.
When it comes to the taxability of interest income, there are a lot of misconceptions in the minds of taxpayers. Our cover story this week looks at where taxpayers may be going wrong and what they should do to get on the right side of the law.
The biggest misconception among investors is that their fixed deposits will remain hidden from the prying eyes of the taxman. The TDS is a dead giveaway for such investors. If the income from fixed or recurring deposits exceed Rs 10,000 in a financial year, the bank will deduct TDS.
This will then show up in the taxpayer’s Form 26AS, along with the interest income earned by the individual during the financial year. Another misconception is that no tax is payable if the bank has deducted TDS.
But TDS is only 10% of the income. If the investor falls in a higher tax slab, his liability would be higher because interest is fully taxable as income.
HOW IS INTEREST INCOME TAXED
Don’t try to avoid TDS
Some investors try to avoid TDS by breaking up their investments into smaller deposits across several banks. If you invest Rs 1 lakh in a fixed deposit that earns 7%, the annual interest will not breach the Rs 10,000 limit even in the fifth year.
But experts warn against such attempts to avoid TDS and evade tax. “It is compulsory to submit your PAN when you invest in a fixed
deposit,” says Archit Gupta, CEO and Founder of Cleartax.in. “There is no way to keep such investments hidden for long.”
“It is compulsory to submit your PAN when you invest in an FD. You can’t hide these deposits even if you invest across multiple banks.” Archit Gupta, CEO, Cleartax.in
Others try to hoodwink the tax authorities by submitting Form 15G or 15H so that their bank does not deduct TDS. These forms are declarations that the individual’s income for the year is below the taxable limit and therefore no TDS should be deducted from the interest.
However, misuse of these forms can invite the wrath of the tax department. “A false declaration not only attracts penalty but also prosecution. The taxpayer can be sentenced to jail for terms ranging from three months to two years,” says Sudhir Kaushik, Co-founder and CFO, Taxspanner.com.
“TDS is not the end of your tax liability. TDS is only 10%. If you are in the 30% tax bracket, you have to pay more tax on the interest earned.” Sudhir Kaushik, CFO and Founder, Taxspanner.com
You need to meet two basic conditions to file form 15G. One, your taxable income for the year should not exceed the basic exemption of Rs 2.5 lakh. Two, the total interest received during the financial year should not exceed the basic exemption slab of Rs 2.5 lakh. Mind you, the total interest income should include interest from other sources, including PPF and NSCs.
Form 15H, which is for senior taxpayers above 60, imposes only the first condition. The final tax on the total annual income should be nil. So, senior citizens whose taxable income is below the Rs 3 lakh limit are eligible to file Form 15H. For very senior citizens above 80, this limit is Rs 5 lakh.
Misusing Form 15G and 15H
Don’t think you can get away by submitting the Form 15G or 15H. Though banks don’t question the investor when he files these self-declarations, the matter doesn’t end there. “Banks are supposed to mention the names and PAN details of such investors in their TDS returns,” says Mumbai based chartered accountant Shubham Agrawal.
This information then makes its way to the Form 26AS of the individual. One can only imagine what will happen to an investor whose Form 26AS indicates submission of Form 15G or 15H at multiple banks and an income that exceeds the basic exemption limit.
Tax filing portal Taxspanner scrutinised the returns filed by assessees and found that almost 90% had not reported any interest income. That’s odd, given that all taxpayers have bank accounts and interest accrues on the balance. This interest is tax-free up to Rs 10,000 a year under Section 80TTA. Any amount above that limit is taxed as income.
However, since there is no tax deduction at source (TDS) on savings bank interest, this income is rarely reported. In future, as banks start
sharing data, TDS could be applied to deposits made across other banks as well.
“The mechanism to track deposits across other banks already exists. If banks share the names and PANs of fixed deposit investors, lakhs of individuals could come in the tax net,” says M.K. Agrawal, Senior Partner, Mahesh K Agarwal & Co.
ARE YOU ELIGIBLE TO USE FORM 15G OR 15H TO AVOID TDS?
The interest earned and total income of the individual determines the eligibility to use these forms and avoid TDS.
Regular taxpayers below 60
Senior citizens above 60
Very senior citizens above 80
All in the family
Another common way to avoid tax is by investing in the name of a non-working spouse or minor children. Money gifted to a spouse or a minor child does not attract tax. But if that money is invested, the income it generates is clubbed with the income of the giver and taxed accordingly.
If a husband has invested in fixed deposits in the name of his wife or minor child, the interest will be taxed as his income. In case of children, there is a small exemption of Rs 1,500 per year per child for a maximum of two children.
Money gifted to spouse is tax-free. But if that money is invested, the income from the investments will be clubbed with the income of the giver and taxed at the normal rate. Income from fixed deposits in the name of minor children below 18 is treated as income of parent who earns more. There is a small exemption of Rs 1,500 per child per year for a maximum of two children.
However, the clubbing happens only at the first level of income. If the amount earned as interest is reinvested and earns an income, it will be treated as the income of the recipient, not of the giver. “The income from the reinvested income does not attract the clubbing provision,” points out Kaushik.
Here’s how you can make this rule work for you. Gift money to your non-working spouse and then invest it in any tax-free investment option. The earning will be clubbed with your income, but since it is tax-free, it won’t push up your tax liability. Your spouse can then reinvest that money. The income from the reinvested income will not be clubbed.
Mom and dad can help
It is simpler if you invest in your parents’ name. If any or both of your parents do not have a high income, while you are in the highest 30% tax slab, you can gift them money to invest in fixed deposits. If a person is above 60, up to Rs 3 lakh earned is tax-free in a year.
Unlike investments made in the name of a spouse or a minor child, there is no clubbing of income in the case of parents. So, a person above 60 can potentially earn Rs 3 lakh per year without any tax implication. If he invests in tax-saving schemes under Section 80C, the income can be as much as Rs 4.5 lakh a year. In the highest tax bracket, this saves nearly Rs 1.4 lakh in tax in a year.
Clubbing provisions don’t apply in case of money gifted to parents. If they invest that money, the interest earned will be treated as their income, not yours.
However, the income of the parent will have to be reported. If it exceeds the basic exemption limit, you will have to pay tax on it. Even so, if the parent does not earn or is in the 5% tax bracket, the tax will be quite low.
“It is perfectly legal to gift money to your parents who can then invest it in FDs. The tax department should not have an objection.” Minal Agarwal Chartered Accountant
HRA also under scanner
Bank deposits are not the only things that the taxman is targeting. Also in the crosshairs is the house rent allowance (HRA) exemption and fake rent receipts. Four years ago, the tax department lowered the threshold limit above which salaried taxpayers had to submit the PAN of their landlord for claiming HRA exemption.
From Rs 1.5 lakh a year, the limit was lowered to Rs 1 lakh (Rs 8,333 monthly rent). From this year, the tax department has made it mandatory for those paying over Rs 50,000 monthly rent to deduct 5% TDS from the payment and deposit that amount with the exchequer.
