Bank deposits are the go-to financial security when it comes to prioritising the safety of returns. Have you ever thought about what return you are earning on the deposit? Anything above 7% per year will be heavily advertised by the bank, but the truth is that bank deposit rates fluctuate too. Not only that the published return is not what you finally earn. A 7% a year interest rate can become 4.8% a year net of tax. 

Similarly, while you choose long term bonds issued by corporate entities or the Government for your long-term regular income, do you know that the interest you receive from some of these is also taxable?

How much tax do you pay on interest income?

Bonds and deposits, both are financial securities which require you to invest a lump sum amount for a specified period of time and for this you receive a pre-determined interest payout at fixed intervals. At the end of the tenure, you will get your original amount and last interest instalment. 

While there is no capital gain, the interest received from bonds and deposits is also taxed. Interest income is taxed along with your other regular income like salary. Hence, the rate of tax is the same as your marginal income tax rate. 

While filing your tax returns you will have to add interest received from bank deposits and bonds after you have added your salary and made adjustments to that. Interest income is included in your overall income for tax purposes. 

Let’s say you fall in the 30% tax bracket, then your 7% per year pre-tax interest becomes 4.83% after considering the basic income tax plus education cess (tax rate of 30.9%).

Any tax already paid on the interest, including TDS, can be shown as part of your tax returns and adjusted against the tax liability finally calculated for the interest received. For this you must get a TDS certificate from the deposit or bond issuer. 

Tax deducted at source

For interest received from bank deposits, a 10% tax is deducted at source (TDS) by the bank if your overall, combined interest income from deposits made with the bank exceeded Rs 40,000. The same rate of TDS applies to interest received from corporate or government bonds and corporate deposits. However, the threshold of interest income received is lower at Rs 5000 for interest from corporate deposits to be eligible for TDS.

Any tax already paid on the interest, including TDS, can be shown as part of your tax returns and adjusted against the tax liability finally calculated for the interest received. For this, you must get a TDS certificate from the deposit or bond issuer. 

There are Government bonds like Tax-Free Bonds, where the interest received is specifically exempt from tax.  

Taxation needn’t be the reason you invest or don’t invest in a particular financial security, but you should be aware of the tax implication. For those in the highest tax bracket, the net result can change meaningfully and your returns may fall short of your original objective if you don’t consider the tax payable.