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There are different types of income that are recognized under the Income Tax Act, 1961. If you are a salaried person, your primary income will be from salaries. On the other hand, if you are an entrepreneur or a self-employed person, your primary income would be your business profits.
Apart from these main sources of income, there is another kind of inflow that you can earn from various financial products and investments. And this is the income you get in the form of interest. In other words - interest income.
What is it? How can you earn interest? And do you need to pay tax on interest income? Let’s find out.
Interest income is the amount you earn from different financial products, accounts and investments. It can be earned when you lend your money to another entity, deposit your funds with a bank or a financial institution, or even invest your money in certain schemes.
Interest income is typically paid out at a specified rate of interest. In other words, it is generally guaranteed. Another key feature of interest income is that it is most often paid out periodically. So, you can earn your interest on a monthly, quarterly, semi-annual or annual basis.
Irrespective of the rate of interest and the frequency of payout, you need to pay income tax on the interest earned from different financial products. To understand how this works, let us first discuss the financial products that offer interest income.
There are different ways to earn interest income, as you may have seen above. Knowing what these are can help you better understand how tax on interest income is levied from one product to another.
A savings account is one of the most fundamental financial products. And this is the most basic kind of interest income that individuals can earn. The money that you deposit in your savings bank account slowly accumulates interest at a specified rate over the months. At the end of the financial year, the interest that you earn will be subject to taxation as per the provisions of the Income Tax Act.
A fixed deposit or a term deposit is a kind of financial product that allows you to earn compound interest at competitive rates. You can deposit large sums of money in your FD account and earn interest at the rates specified. This interest can be reinvested in your fixed deposit over the specified tenure, as in the case of cumulative FDs.
Alternatively, you can also opt to have the interest paid out to you. In this case, you can earn periodic income on a monthly, quarterly, semi-annual or annual basis. Irrespective of whether the interest is paid out or reinvested, you must pay income tax on the interest earned.
Recurring deposits allow you to deposit a fixed sum of money in your RD account periodically. At the end of the specified tenure, the total amount that you have deposited is paid out to you along with the interest thereon. This interest income too is subject to taxation.
Bonds issued by government entities and corporate entities are both preferred investment options. These bonds are typically long-term assets, and they pay out interest at the coupon rate specified on the bonds. The interest may be paid out periodically, or it may be paid out at the time of redemption of the bond.
The Public Provident Fund is one of the most popular tax-saving investments in India. It has a tenure of 15 years. And the amount that you deposit into your PPF account each year earns interest at the rate specified by the government of India. Currently, the rate of interest on PPF investments is 7.1% per annum.
This interest is paid out at the time of withdrawal of investments from the PPF account. But do you have to pay income tax on interest income from PPF? Find out in the next section below.
Now that you have seen a preview of the different ways in which you can earn interest, let’s discuss the tax on interest income from each of the sources above.
The interest you earn on your savings account is taxed as other income. However, you can make use of certain provisions of the Income Tax Act to save tax.
If you are not a senior citizen, you can claim a deduction up to Rs. 10,000 under section 80TTA. This limit includes the interest income from all the savings bank accounts you own and operate.
On the other hand, if you are a senior citizen, you can claim a deduction up to Rs. 50,000 under section 80TTB.
You also need to pay income tax on interest earned from fixed deposits and recurring deposits. This income is also taxed as income from other sources, at the income tax slab rate applicable to you.
However, when you opt for FD interest payouts, most banks typically deduct TDS at 10% if your interest income is Rs. 40,000 or higher. For senior citizens, this is Rs. 50,000 or higher. If you do not have a PAN, the TDS rate is 20%.
But if your total income from all sources is below the basic exemption limit, you can avail an exemption from the tax deduction. To do this, you must file a self-declaration form (15G for non-seniors and 15H for seniors).
In the case of corporate bonds, the interest income is taxed as income from other sources. However, if you have invested in tax-free government bonds, there is no need to pay income tax on interest income. This is because the interest is tax-free as per section 10(15)(iv)(h) of the Income Tax Act, 1961.
The Public Provident Scheme (PPF) is an exempt-exempt-exempt investment option. This means that the amount invested, the withdrawal amount and the interest earned are all tax-free. So, you need not pay any tax on the interest income from PPF.
Most kinds of interest income are taxed under the category of ‘income from other sources.’ In other words, they will be taxed at the rate of tax applicable to your income slab. However, some interest, like interest from your Public Provident Fund investments, can offer tax benefits.
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Yes, the interest earned from your savings account is clubbed with your regular income and taxed under the head ‘income from other sources.’
Income tax on interest earned is typically taxed as income from other sources. In case your business involves lending money, the interest earned on your loans is taxed as business income.
Banks deduct TDS on fixed deposit interest income at the rate of 10%. However, if you opt out of TDS deduction, you will have to pay tax on interest income from your FD at the income tax slab rate applicable to you.
Form 15G is a self-declaration form that you can submit to your bank. It is a request asking your bank to not deduct TDS on interest since your income is below the basic exemption limit.
As per section TTA of the Income Tax Act, you can claim interest from your savings account as a deduction from your total income. The maximum limit of deduction allowed is Rs. 10,000 per financial year.