Are you paying Income tax on Interest Income?

As part of direct taxes, all of us are paying Income tax to Government of India. Income tax is levied on following two parts of income:

1. Earned income which is earned by us in a financial year(Apr to Mar)
2. And the interest income which gets accrued on our savings / investments

There is hardly any scope to save income tax on earned income beyond what is available as part of deductions in different sections of Income tax Act e.g section 80 C, 80 D etc

But how much Income tax we pay on our interest income depends entirely on us. Most of our money either keeps lying in Saving Bank Account(SBA) or Bank FDs and we land up paying almost 31% of interest income as Income tax. 

So is there any way out?

Instead of keeping surplus money in Saving Bank Account or Bank FDs, we may like to invest this money in debt mutual funds. There is no tax liability as long as you remain invested in debt mutual funds(no TDS). If you remain invested for at least three years, you qualify for long term capital gains (LTCG). Should there be any requirement for redemption after three years, you get tax advantage on LTCG due to indexation and flat tax rate of 20%. Effective tax rate works out to be approx 8-9 % for people in 30% tax bracket.

let’s understand through an example. Let us assume we invested Rs 1 Lakh for 3 years and 1 day in a short duration debt fund in FY 2014 – 15 and redeemed in FY 2017 – 18. Assuming annualized pre-tax return was 7% compounded for these three years, tax calculations would be as shown below:  

In case of Bank FD, tax liability would have been Rs 6751/- assuming same rate of interest thus saving almost 73% on taxation.

And  on top of it, you get better returns on debt mutual funds as compared to SBA / Bank FDs.

Think over it…