Low returns, set tenure, tax on interest play spoilsport

In 2006, bank deposits held for five or more years were exempt from tax in the hope that this would draw retail investors to park more long-term money with banks. But seven years on, numbers belie the hope. These deposits have not proved a big hit.

The proportion of five-year plus deposits in the fund base of banks has not changed much in these years. Eleven per cent of total bank deposits was parked in five-year plus deposits in 2006. In 2011, the number was barely changed at 12.3 per cent.

Nor have depositors shown any special preference for these deposits — over the short-term ones — because of the tax-break they offer. Between 2006 and 2011, five-year plus deposits registered a 22.6 per cent annual growth, only slightly higher than the 21 per cent growth in the term deposit base of banks.

Why have tax saving deposits failed to take off? One of the key reasons seems to be the rather unattractive interest rates offered. Looking at the trend of interest rates across various deposits (by tenure), that for deposits with maturity of more than five years have often been similar or even lower than what is offered for lower tenures. In 2011-12 for instance, while five-year deposits offered 8.5 to 9.25 per cent, those for two-five years fetched 9-9.25 per cent. In fact, the rates particularly under the tax- saving schemes range between 8 and 8.5 per cent.

While initial deposits up to Rs 1 lakh are tax-free, interest payments are taxable. This take the shine off this investment relative to other tax-saving options. While tax saver deposits up to Rs 1 lakh are exempt under Section 80 C, interest earned is treated as “Income from other sources” for the purpose of taxation. Hence, banks are required to deduct TDS (tax deducted at source), currently at 10 per cent before crediting the account. Hence, the attractive ‘yields’ of 16-odd per cent that most banks claim to sell this product are usually pre-tax workings.

Financial advisers point out that comparable tax saving options in the fixed income category — National Savings Certificate (NSC) and Public Provident Fund (PPF) — offer higher rates that are also tax free. The five-year NSC offers 8.6 per cent. What makes it attractive is that the interest — compounded half yearly — is treated as reinvestment until the penultimate year. Similarly, PPF interest rate stands at 8.8 per cent and the interest income from PPF is tax free, making this option attractive.

Added to this is the lock-in period of five years. “The tax-saving FD, despite being a bank product, cannot be pledged as security for loan. The illiquid nature and long tenure make it less popular vis-à-vis against equity linked saving schemes (ELSS) and other similar tax-saving instruments” says Adhil Shetty, CEO, Bankbazaar.com.

As part of the pre-Budget discussions, bankers have put forth a request to reduce the lock-in period from five to three years to bring it at par with other tax-saving schemes like ELSS.

radhika.merwin@thehindu.co.in

(This article was published on February 2, 2013)
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