How to match the interest earned on fixed deposit with the tax deducted by the bank?

Fixed deposits (FD) is the most convenient and simple instrument of investment. In this you can know about the earnings at the time of making deposit but the difficult part is to match the amount of interest earned on these deposits with the amount received and the tax deducted at source.

Let us take a case study to understand this point.

For instance Rajesh invests Rs 100,000, for one-year each in two FDs, in the financial year 2009-10. One investment he did in the beginning of the 2009 and will mature in March 2010 at the rate of interest of 7%. The second investment he did in July 1, 2009 at 7.2 per cent. Both the FDs will give simple interest cumulated at maturity, though for accounting purposes the amount accrues to the investment at the end of each quarter. In case Rajesh considers the interest earned when it is received, how will he account for the second deposit? How to match the interest earned with the tax deducted by the bank?

How to tackle this issue

First, what is the method of recognizing the income or interest earned? One is the accrual method in this the amount accrued on the deposit during the year is considered as income, even if not received. The other is the income when actually received, the cash way of accounting.

Generally an investor will find the former method convenient, especially when the income with a bank is crossing Rs 10,000 in the year. Therefore, Tax Deduction at Source (TDS), will be done, it will be in tune with the route adopted by the bank.

Here, the bank will consider the income earned by the depositor till the end of financial year and then deducts the tax on it.

The tax authorities have said banks should deduct TDS only on the amount credited and not on the provisions made. Thus, Rajesh must know when bank is crediting income to his account, in this case, quarterly, and this is the figure to be taken for accounting purposes.

In this case the income will be credited with the maturity, for the deposit that is maturing in March 2010. Thus, the interest earned will be Rs 7,000 for the year. The interest earned will be included in the investor's total income. Hence the income is actually received, so there is no complication.

The second deposit will also pay the amount at maturity. This deposit will mature in one-year time on July 1, 2010. As it is clearly stated that deposit amount will accrues at the end of every quarter, there is a need to consider the income earned till the end of March. The bank will follow the same procedure and they will use this for tax deduction. The income earned, here, will be Rs 5,400 till the end of March. Hence the investor should consider the income till March 2010, even though he may not have received the amount from the bank.

The tricky part is the alignment for taxation. The investor will get the net amount after TDS, as the amount of interest earned will be crossing the limit of Rs 10,000 during the year. Let us make it simple for understanding. Suppose the interest of rate is 10 per cent (without cess) for tax deduction. Thus, the amount received by Rajesh will be reduced by Rs 1,240 (10 per cent of 7,000 plus 5,400) for the TDS and the net amount received will be Rs 4,160.

To calculate the total income earned during the year, Rajesh cannot add the amounts received, as there is a TDS amount involved. He has to gross the total amount earned, which will be Rs 7,000 plus Rs 5,400 that is a total of Rs 12,400. This figure will be included in the income for the year under the head of income from other sources. Thus, the total amount of income and the tax payable on this income will be calculated. From this, the TDS amount has already been deducted by the bank, Rs 1,240, will be adjusted and the whole process is completed.