Understanding Tax-exempt interest

Tax-exempt interest refers to income not subject to taxation, often from municipal bonds.
Tax-exempt interest
3 min
11 April 2024

Every earning individual in the country has to pay income tax if they fall under the tax bracket. While the thought of a tax-free income and a tax-free interest income is incredible, in reality, it is not easy to save on taxes. This is because many people may not have a sound understanding of taxes.  The rate of financial literacy in India is slightly over a quarter, meaning that more than 70% of the general population is not financially literate. These figures are even lower when it comes to the people who understand the basics of money management, with that number being under 20%.

Income tax is also a significant source of revenue for the government. It enables them to invest in welfare projects and subsidy schemes, among other projects and domains. However, to encourage people to pay taxes, the government also provides several exemptions for individuals and encourages them to invest that amount.

The most popular savings instruments in India are savings accounts and fixed deposits. While the former is a regular bank account and earns modest interest over time, the latter is a term deposit with a lump sum put away for a fixed tenure, earning stable interest. However, interest income earned from these sources is taxable after a limit. Thus, it becomes important to understand tax-exempt definition, tax-exempt interest, and how to generate tax-free interest income to maximise savings and reduce the tax burden.

What is tax exemption

The first important term to understand is, what is tax exemption. Tax exemption refers to things that do not come under the purview of taxation. Income that is tax-exempt, for example, will not be taxed and can be fully utilised as revenue and savings. Understanding what is tax exemption is crucial as we learn about tax-exempt interest.

Importance of tax-free interest income

Tax-exempt or tax-free interest income refers to revenue streams that generate interest that remains tax-free. This means that these are investments that not only help you save but further reduce tax liability. The tax regime in India is governed by the guidelines laid out in the Income Tax Act of 1961. While the act highlights provisions and exemptions—and we will delve into these, let us first understand why the need for tax-free interest income arises in the first place. We will do this by taking the example of two of the most common saving options in India.

First is the example of savings accounts. By definition, savings accounts are designed to hold your earnings securely while gaining a decent interest over time. Interest earned on such savings is categorised as ‘income from other sources’ and is taxable beyond Rs. 10,000 p.a. A key point here is that the tax exemption limit on interest income for senior citizens is Rs. 50,000. Thus, even if you consider it a tax-free interest income, it has a ceiling of Rs. 10,000 per year (Rs. 50,000 for senior citizens).

The second most common saving and investment instrument among Indians is term deposits, specifically fixed deposits. Fixed deposits (FDs) are reliable and secure. However, the interest earned from fixed deposits is also categorised as ‘income from other sources’ under the Income Tax Act. If the interest earned from a fixed deposit is more than Rs. 40,000 a year, the interest would also be taxable. Thus, interest generated through FDs is also not completely tax-exempt income.

Nonetheless, fixed deposits remain popular among Indian citizens. Bajaj Finance FD is a secure way to invest your hard-earned money, with interest rates up to 8.85% per annum. This comes with the highest ICRA (AAA/Stable) and CRISIL (AAA/STABLE) ratings, ensuring your deposits remain secure. You can book the FD by visiting the Bajaj Finserv website or downloading the Bajaj Finserv App.

Sources of tax-free interest income 

Income tax comes into the picture for all your earnings. Earning interest on your wealth over time is a great way to generate returns. However, these returns are also largely taxable. Let us now understand a few sources of tax-free interest income for Indian citizens and residents. These schemes and provisions are important to know as they help you plan your finances better and achieve financial freedom.

In the Income Tax Act, Section 10 outlines cases where interest income you generate will be exempted from income tax. Some of the major provisions are:

  • Section 10 (11) - Interest earned in Statutory Provident Fund
  • Section 10 (12) - Interest earned in a Recognised Provident Fund, up to 9.5% per year
  • Section 10 (11A) - Interest earned in accounts opened under the Sukanya Samriddhi Account
  • Section 10 (26) - Interest income earned on securities by certain specific groups of Scheduled Tribes residing in specified areas (like Ladakh, Manipur, Arunachal Pradesh, Nagaland, among others).

If you are looking for safe investment option, then you can consider investing Bajaj Finance Fixed Deposit. With a top-tier AAA rating from financial agencies like CRISIL and ICRA, they offer one of the highest returns, up to 8.85% p.a.

Conclusion

Learning about tax-exempt definition is essential for every individual looking to optimise their financial planning and minimise tax liabilities. Understanding tax exemption becomes even more critical in a country with relatively low financial literacy rates. While income tax is vital for government revenue, you are encouraged to explore sources for tax-free interest income within the legal framework to reduce your tax liabilities. Key provisions within the Income Tax Act, such as Section 10, offer opportunities for tax exemptions on various types of interest income, from savings accounts to specific investment schemes. By leveraging these exemptions effectively, you can enhance your savings, reduce your tax burden, and work towards achieving your financial goals.

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Disclaimer

As regards deposit taking activity of Bajaj Finance Ltd (BFL), the viewers may refer to the advertisement in the Indian Express (Mumbai Edition) and Loksatta (Pune Edition) furnished in the application form for soliciting public deposits or refer https://www.bajajfinserv.in/fixed-deposit-archives
The company is having a valid Certificate of Registration dated March 5, 1998 issued by the Reserve Bank of India under section 45 IA of the Reserve Bank of India Act, 1934. However, the RBI does not accept any responsibility or guarantee about the present position as to the financial soundness of the company or for the correctness of any of the statements or representations made or opinions expressed by the company and for repayment of deposits/discharge of the liabilities by the company.

For the FD calculator the actual returns may vary slightly if the Fixed Deposit tenure includes a leap year.