Under the present income tax law and rules, interest income earned on any loans extended or deposited with bank (eg., fixed deposit FDR’s) are taxed under the head “Income from Other Sources”.
The law provides for specific items eligible to be deducted from such income prior to levying tax thereon, inter-alia Section 57(iii) extracts relating to deduction allowable from “Any other income.”
“Any other expenditure (not being capital expenditure) expended wholly and exclusively for earning such income.”
Logically, any interest incurred by the individual/assessee on any loans taken ought to be allowed as deduction from the said taxable interest earned. This is all the more relevant and pertinent in the case of “individual” assesses’ particularly those who do not have any income heads which could subsume the interest incurred on the loan.
Weirdly however, the law (extracts as reproduced above) suggest that only such interest, as is incurred on loan funds used to earn the “taxable” interest, is eligible to be deducted. This is a patently contra indication and rather an inhumane provision in the circumstances referred in the preceding paragraph more so because this rule effectively but impudently taxes the assessee for “access to liquidity” rather than “having earned income on his/her capital”.
The world of economics provides for considering “opportunity cost” and/or “imputed costs” as an essential element in computing actual/ real earnings. Besides, modern times and uncertainties entail that a wise person maintains a cushion of liquidity to provide for any exigencies.
Illustrating the scenario with a real life example drives home the point seamlessly.
Imagine a person having 15 lakhs of fixed deposits with a bank which earn him/her approximately a lakh of rupees in interest annually. He/she has to pay tax thereon and which is very fair as per the law in force. Now if the said person buys a car on EMI or takes a personal loan for marriage incurring an interest thereon of say one lakh rupees, he/she should be entitled to offset the outgo from the interest earned so that the tax liability on the earned interest would stand nullified; this too would be just as equally fair and reasonable (since the effective interest income is zero) as taxing the interest income when there was no loan. This is also because when the loan was secured, the assessee had the option to use/consume his own capital to fund the car/marriage (by encashing the bank deposit) – had he/she done so, they would have ceased to earn any interest thereafter and would not be obligated to pay any tax either since the erstwhile interest income would stand vanished. However, the assessee apparently chose to take a loan (which in turn is granted basis the assessment of his/her repayment capacity by the lender institution) so that while the loan can be redeemed piecemeal over the contemplated tenor, the assessee would continue to enjoy the comfort of liquidity all the while at his/her command and discretion. This is regardless of the loan itself having been sanctioned with or without the FDR’s as collateral. Post such a financially wise and feasible scheme, no (net) interest is accruing to the assessee – he/she is getting interest on one hand while expending from the other. To be taxed for the former is only unjust, unfair and inhumane to say the least.
Unfortunately the law as it stands, continues to tax the individual for the FDR interest earned regardless of the interest incurred on the car loan or the personal loan since the latter is not allowed as a deduction. This is so done pursuant to the restriction in the tax law stated above as apparently the interest earned is not financed out of the funds from the loan taken. This tantamounts to exhibiting a narrow mindset.
A broader perspective would evince that the entire scene is made possible thanks to new generation finance models which have continuously evolved over the last 3 to 4 decades – where EMI financing is a conspicuous part of most households. To tax the assessee therefore is nothing short of retribution for subscribing to modern day economic models which allow the household to hold on to deposits for contingencies while being able to buy the gadgets or fund specific events through EMI loans.
Fact that taxing the interest earned on deposits (without allowing deduction for the interest incurred on loans taken) is even technically wrong and untenable can be established from a manoeuvre that would be legally allowed in the scenario – it involves the assessee doing the following step wise:
– prematurely encashing the FDR,
– using the proceeds for buying the car or funding the marriage,
– securing a personal loan and/or loan on an existing car (note that fund utilisation is not tracked by the lender in most such cases) and
– use the loan funds to purchase new FDR
Post completing these steps, the assessee is earning interest from funds which are first hand secured from the loan funds – ergo the tax rule being satisfied, the assessee is saved of the tax liability while he/she is able to restore the cushion of enjoying liquidity as available in the previous model.
However, such tax saving is made possible only by undergoing the otherwise avoidable grind (because a broader view would reveal that the four steps suggested above are akin to manipulation, which though legal, are virtually a set of book entries in the overall/larger banking system in a specific order.
Just because the tax law is not considerate enough to appreciate this predicament in advance, it goes to prompt the wiser one to manoeuvre the financing scheme to legitimately avoid tax all of which is otherwise a bookish exercise best kept at bay but for the archaic law provision(s).
Humane approach to this conundrum beckons that the tax rules are updated to get rid of this outdated anomaly.