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Is interest earned through investments taxed?

Relax With Tax | September 06, 2005

We were recently asked a very interesting question by a client who seemed rather pre-occupied with the tax on the interest he earns.

Image"If the investment in National Savings Certificates comes under Section 80C, what about the interest earned on it?" was the first question he shot at us.

The next one concerned the interest he earned though his savings bank account.

He is aware that dividends from mutual funds and company shares are tax free in the hands of investors.

But the dividend gets credited directly to his savings bank account on which he earns interest. "Is this interest on the bank account taxed?" was his query.

Since these issues affect virtually every one of you, we thought we would explain it in detail.

What was Section 80L?

If you invested in certain instruments specified by the government, you did not pay any tax on the interest you earned on those instruments.

This meant that, while the interest you earned was taxable, you could claim a deduction if the investment fell under Section 80L.

Under this section, interest in certain investments could be exempt from tax. The limit upto which you could claim deduction on interest was Rs 12,000.

Examples: Interest from the NSC and infrastructure bonds.

What was Section 88?

Section 88 offered a rebate. When the government gives you a concession on your income if you invest in certain instruments, it is known as a rebate.

The actual amount of the rebate varied according to the income slab.

Section 80C replaces Section 88 and Section 80L

Now, you have something called Section 80C, under which you can claim relief for the following investments:

  • Provident Fund
  • Public Provident Fund
  • Life insurance premium
  • Pension plans
  • Equity Linked Saving Schemes of mutual funds
  • Infrastructure bonds
  • National Savings Certificate

The payments towards the principal amount of your home loan are also eligible for an income deduction.

The limit under Section 80C

The limit under this section is Rs 100,000.

This is irrespective of how much you are earn and under which tax bracket you fall.

Also, unlike the earlier Section 88, there are no sub-limits under this overall Rs 100,000 amount.

So, if you choose, you can invest the entire amount in ELSS or infrastructure bonds. The choice, as to how you want to reach this limit, is entirely yours.

Or, if you are repaying a home loan and the principal repayment amounts to Rs 100,000, you can claim the entire amount as a deduction.

To make this clearer, check out the following example:

Let's say your taxable income is Rs 100,000. You invest Rs 70,000 in the PPF. Your taxable income drops to Rs 30,000 (Rs 100,000 - Rs 70,000).


Earlier, your NSC investment got you a rebate under Section 88 rebate and a benefit under Section 80L, both of which are explained above.

Now, it only gets the benefit under Section 80C. This is for the principal amount you invest.

What about the interest you earn on NSC?

The interest earned on NSC would be included as income under the head 'Income from other sources'.

In case you were unaware, the various heads of income are:
i. Salary
ii. Income from house property
iii. Profits and gains from business or profession
iv. Capital gains
v. Income from other sources

Got it? Unlike the previous year, the interest you earn no longer has the shelter of deductions under Section 80L. Now, the entire amount of interest under NSC would be taxed.

Bank interest

The interest from bank accounts would be taxed at the slab rate applicable to your total income.

Say we consider a scenario where you have two sources of income.

Salary income
The taxable salary income is
Rs 500,000

Income from other sources
The interest from NSC, fixed deposits and the bank interest rate amounts to Rs 10,000.

When this is totalled, you will fall in the 30% tax rate slab.

In a nutshell, you no longer get a tax benefit on the interest you earn; you only get a benefit on the amount you invest. 

Though do note, dividends from shares and mutual funds are still tax free.

Share your comments

 What do you think about the story?

Read what others have to say:

Number of User Comments: 6

Sub: is interest on investment taxed

Educative. Please clarify if a person ends to his wife 10lakhs at 1%p.a to his wife and she inturns invests in Goi bonds, whether the ...

Posted by c.jayaram

Sub: section 80 C and EET / EEE

The Budget 2005 has not only brought in the concept of EET ( as against both EEE and EET prevailing earlier for different schemes). As ...

Posted by anil

Sub: Is interest on investments taxed

Sir, I am not a tax expert but articles like yours add to our knowledge. You have given the tax laws in simple language understood ...

Posted by DR, Tirath Garg

Sub: Tax on interest accrued on NSC.

I am of the opinion that interest accrued on NSCs purchased during earlier years till maturity is to be treated as "Income from other source" ...

Posted by U.Raghuveer Kini

Sub: Section88 is removed in the new IT rules

Hi, It states in this message that we can invest in sectin 88 and till get a rebate. But 2005-06 budget (IT) has changed it ...

Posted by Nag


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