How To Avoid Paying Taxes On Interest On Investments
The interest on some investments such as Bank Fixed Deposits and National Savings Certificates is taxable. This reduces the initial rate offered by banks from around 10 per cent to about 6 percent, leaving you with hardly any earnings from this type of investment.
One loophole out is Section 56 of the Income Tax Act. This section basically exempts cash gifts between relatives. This includes relatives such as parents, spouse, siblings and adult children. As you know, the basic threshold for paying income tax is Rs. 1.50 lakh for men, Rs. 1.80 lakh for women and Rs. 2.25 lakh for Senior Citizens above the age of 65 years. For this tax loophole to work, it is necessary that your relatives have zero income or income which is much less than the basic income tax threshold for their age/sex.
Now here comes the tricky bit - All you have to do to save tax on fixed deposits is to gift large sums of money to your wife, parents or adult children and invest this cash in fixed deposits or some other investment of your choice. The resulting interest on the fixed deposit, if below the basic threshold limit is completely free of tax. Let's take an example -
Mr. Singh is a Senior Manager in an IT firm. His wife and 80 year old mother are housewives, while his 19 year old son is a college student with no earnings. After using up all the tax saving investment and expense options, Mr.Singh has Rs. 30 lakh spare for investing. As the share market is down, he decides to avoid shares, mutual funds and life insurance. The next best thing is fixed deposits, the only negative point being that the interest on such an investment is taxable.
Hence, he makes use of the above income tax loophole. He gifts Rs. 10 lakh each to this wife, mother and son. This is in turn invested in fixed deposits that earn 10 percent per year in his wife, mother and son's name. Each relative earns around Rs 1 lakh as interest from this investment. However, this interest is not taxable as it is below the basic threshold taxable limit of Rs. 1.80 lakh for wife, Rs. 2.25 lakh for mother and Rs 1.50 lakh for son respectively.
If Mr.Singh had invested the above funds himself, he would have to pay full tax on the Rs.3 lakh interest earned, which would have been a straight loss. Since, he had relatives he could trust, he saved a lot of cash for the family and also gave them financial security.
Of course, you might not have Rs. 30 lakh to spare after household expenses and tax, but whatever savings you have, you can put this tax saving strategy to good use to avoid paying taxes on various investments such as fixed deposits and national savings certificates that have taxable interest.
- Tax Slabs in 2009
- Best Tax Saving Investments
- Calculating Taxable Income for Salaried Individuals