Fixed deposits are inherently tax inefficient...
Any interest on them is 100% taxable. And to add to that this interest is also subject to TDS in case it's more than 10k INR/year.
Now, even if you are otherwise under the overall exemption limit, by default, TDS will still get deducted from your account.
And once its deducted, it becomes a game of waiting. You first wait to file your returns and then you wait for the tax refund to actually happen.
Won't it be simple if you could avoid this TDS altogether? But can you even do that?
Well, yes, you can...
And in this post I will cover 5 ways to minimize your TDS...
But before we get into those exact methods, let's first cover some basics.
TDS Rules for FDs
As per current regulations, banks are required to deduct Tax (TDS) at a 10% rate for all those accounts where the total interest income is more than 10k INR in any given financial year.
Please note that interest income less than 10k is still taxable. In fact, any income from FDs, regardless of its exact amount, is fully taxable.
It's just that there will be no TDS on income less than 10k.
But, even though your bank doesn't deduct TDS on amounts less than 10k INR, you are still liable for paying taxes as per your actual slabs.
Moreover, this interest is calculated on an accrual basis and not on redemption.
What that means is that even if you don't redeem your FD, you will still have to pay taxes on all the interest earned during the year.
This is true even if that interest hasn't been paid or credited to your account yet.
E.g. On April 1st, let's say you make a fixed deposit of INR 10 lakhs at 7% rate for a period of 3 years.
Now your investment will actually mature after 3 years, but you still have to pay tax on interest that gets accrued each year i.e. during the first year itself, your accrued interest income will be 70k out of which 10% will be deducted as TDS by your bank.
In case your PAN number is not updated with the bank, the TDS will go up to 20%.
It's also important to note that this 10% is not the only tax liability that you have on your fixed deposit income.
Rather, it's just an initial deduction and you may have to pay more.
For example, if you are in 30% slab, you will need to pay an extra 20% tax to IT department even though TDS has already been levied.
You can verify TDS deducted against your name by downloading your Form 26AS..
TDS can be a bit painful to manage as it may get deducted even if you are not liable for any taxes.
Fortunately, there are five ways out there to avoid and minimize this tax.
Let me start with the first one...
Method 1 - Submit Form 15G/15H
Suitable for: Some, Recommended: Yes
If you are otherwise under the overall income exemption limit, you can simply submit Form 15G to your bank to avoid TDS.
This form will instruct your bank to not do any deduction on your FD interest income as you have no net taxable income.
Any senior citizen or anybody who is turning 60 years of age in the current financial year, have to fill Form 15H. But regardless, it works mostly the same.
As per current regulations, these forms can be filled by any citizens and HUFs (except NRIs) if the final tax on their total estimated income in the financial year is Zero.
Do note that you will have to file a fresh form 15G/15H every single year as this declaration is only valid for the current financial year.
Also, it's recommended to file these forms right in the beginning of the year. Filing these forms in the beginning of the year avoids a situation where the bank has already deducted and deposited tax with the Government.
Why that matters is because, once a bank has deducted TDS, it won't refund you even if you submit a Form 15G/15H. Rather, you will have to file your tax return and claim deducted TDS as a refund.
Also note that submitting Form 15G/15H only works if your PAN is mapped to your bank account. If it is not mapped, your bank will still deduct TDS at a 20% rate regardless of whether you have submitted these forms or not.
Finally, I must say that these forms are meant to avoid the TDS for genuine fully exempt cases and not to avoid paying taxes. In fact, filing false forms may be punishable so never ever do that.
You can get these forms from any bank branch. Or alternatively you can download the printable copies online.
Some banks have also started allowing submission of Form 15G/15H through their netbanking facility. So feel free to make use of that.
Method 2 - Split your FD across banks
Suitable for: All, Recommended: No
You can avoid TDS by splitting your fixed deposits across multiple banks in such a way that overall interest in one single year in one bank doesn't exceed INR 10k.
In fact, earlier it was possible to split these FDs across different branches of the same bank, but 2015 Budget has plugged that loophole.
However, splitting your FDs doesn't actually reduce your tax liabilities. As you will have to anyway include your total interest income while filing your annual tax returns.
I don't recommend this method as it comes with an unnecessary headache of maintaining different bank accounts while doing nothing to reduce your overall tax liability.
Frankly, the Form 15G/15H method is infinitely simpler. And there are other methods that actually reduce your tax liabilities.
Method 3 - Time your FD
Suitable for: All, Recommended: No
You can minimize TDS on your FD income by timing your investment such that the interest earned in the first financial year doesn't exceed 10k.
E.g. If you invest 2 lakhs in an FD on April 1st, you will have an interest income of 12k at 6% annual rate and hence a TDS of 10% will be deducted.
But, if you make the same investment on October 1st, your interest income for the first year will be 6k which is not liable for any TDS deductions.
This method only works if you are doing your FD investment in the middle of the year and it only works for the first year.
This is another method that I don't recommend as there is no point losing on interest income while waiting for the middle of the year.
You should rather earn that extra 2-3% and pay tax on that.
Method 4 - Register as an HUF
Suitable for: HUFs, Recommended: Yes, Strongly
I bet you didn't know about this option...
No surprise, if you didn't as HUFs and taxation policy on them is almost a guarded secret.
HUF stands for Hindu Undivided Family. But, regardless of that name, all Hindus, Buddhists, Jains and Sikhs are eligible to form one.
The beauty about any HUF is that it has its own identity that is considered completely separate from that of individuals who form part of it.
That also means that each HUF will have a separate PAN and any income it generates will be taxed independently. It will also be eligible for any deduction and exemption limits independently.
For illustration, if you, your wife and two children create an HUF, all 4 of you as well as your HUF can claim a deduction.
In other words, you can make one fixed deposit in your name and the other in HUF's name, legally the taxes on these two deposits will be calculated separately.
If you maintain <10k interest income in these accounts, you won't face any TDS at all.
But, goodness of HUFs doesn't stop there.
And in fact, HUFs can be used to legally reduce your tax liability (and not only TDS) on your FDs to zero.
Do an 80C investment on behalf of your HUF. And then Submit a Form 15G to the bank where you maintain your HUF account.
HUFs are eligible for all deductions and once you submit Form 15G on their behalf, there will be no TDS and no Tax till it crosses overall exemption limits
Now, an HUF is eligible for 2.5 lakhs of tax exemption just like any individual. Further, it can claim a deduction benefit of 1.5 lakhs under Section 80C.
You combine these two benefits together, and you can avail of a tax free FD for an amount as high as 50-60 lakhs.
Method 5 - Look at other forms of debt income
Suitable for: All, Recommended: Yes, Strongly
As I said right at the start of this post, fixed deposits are inherently tax inefficient.
But there are other forms of debt income, that work much better.
These investment options are equally good or better than FDs from returns perspective and are much better from taxation perspective.
Public Provident Fund is first such option. The returns are actually higher than most fixed deposits and they are completely tax free. The biggest con with PPF is the initial lock-in period of 15 years and an overall investment limit of 1.5 lakhs/year.
The second option you have is Tax-free bonds. These bonds are issued by various PSUs to raise capital quite regularly and they offer returns comparable to FDs. As their name states, the interest income from these bonds is completely tax free.
They come with a long maturity period, typically ranging between 10-15 years, but are fully tradable on the secondary market. Essentially, they are liquid.
The only con of these bonds is that unlike FDs where you can invest whenever you want to, you can purchase Tax-free bonds only at the time of its issue or from the secondary market at some premium.
Finally, and this is my recommendation... Stop investing in FDs, rather invest in a liquid or ultra short term debt fund.
Liquid funds have a much better liquidity, come with almost equal or better returns and have a favorable tax treatment as compared to FDs.
While FDs are taxed at your tax slab regardless of their duration, all debt mutual funds, including liquid and ultra short term debt funds, are taxed at 20% after indexation for more than three years of investments. However, for the first three years, the tax liability is as per your slabs in both cases.
But a big advantage debt funds have over FDs is that even for less than three year durations, returns are taxed only when funds are actually redeemed (and not on interest accrual as is the case with FDs). This means that you can plan your redemptions to minimize your tax outflows.
Additionally, there will be no TDS in case of debt funds, none at all...
So what's the catch...
The catch is that liquid funds don't guarantee a rate of return in advance.
However, that doesn't mean that these funds are risky.
In fact, their returns are as stable as they get as these funds only invest in low risk instruments with a maturity of less than 91 days.
Actually, to think of it, I have never seen a liquid fund suffer any loss.
Which debt funds should you choose as an alternative to fixed deposits?
Do not invest in the medium or long term debt funds as they will have a much higher volatility. Rather stick to liquid funds (or at max to ultra short term funds).
Final Summary: How to save TDS on Fixed Deposits
File Form 15G/15H
Yes, if it helps you
Split your FDs across different banks
Time your FDs to middle of year
Create an HUF and invest in its name
All who are eligible to form HUFs
Yes, Strong Recommendation
Look at other debt investments
Yes, Strong Recommendation
I hope this is useful and please let me know in case you have a question.