Salaried Taxpayers: Whether offering FDR interest on accrual basis is mandatory?

 

One of the common questions by many taxpayers is regarding the taxation of Interest on Bank FDR. The question raised is whether on receipt basis or due basis?

Before replying on this part, first let us read what section145 of the Income Tax Act-1961 says. It reads as under:

 

 

Method of accounting.

145. (1) Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

(2) The Central Government may notify in the Official Gazette from time to time income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income.

(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) has not been regularly followed by the assessee, or income has not been computed in accordance with the standards notified under sub-section (2), the Assessing Officer may make an assessment in the manner provided in section 144.

Interest on the bank deposits could be chargeable to tax either under the head “Income from Business or Profession” or “Income from Other Source”. For salaried and other taxpayers who are not in business, the interest income would obviously be taxable under the head “Income from Other Source”.

By reading section 145, One can draw following conclusion:

1. Income Tax Act provides that any income falling for taxation under the head “Income from Business or Profession” or “Income from Other Source” shall be charged to tax in accordance with the method of accounting regularly employed by the taxpayers. As such, the taxpayers have an option to offer Interest income for taxation (a) on accrual (due) basis on year on year basis (it is known as mercantile system of accounting) or (b) at the time of maturity of the FDR only (it is known as cash system of accounting).
2. The option of choosing the method of accounting/recording the transaction in the books for taxation is freely available with the taxpayers. However, once taxpayers adopt any particular method, it should be consistently & regularly employed.
3. With the above provision in mind, taxpayers can offer the interest on FDR at the time of maturity also if they choose to follow the cash system of accounting.
4. The next question arises is what if the FDR maturity is not withdrawn and the same is renewed again. Whether taxation of interest income can be deferred by this mode?
5. One may note that as far as renewal of bank FDR is concerned, it is normally presumed that the interest has been paid by the bank and the renewal tantamount to investment (or say reinvestment) of the interest amount back by the depositor. As such, the renewal of FDR may not result in the deferment of the taxation of interest income and the amount of interest will be taxable even if the taxpayer is opting for the cash system of accounting.
6. Whether it is advisable to follow a cash system of accounting for deferring the taxation of FDR Interest income?
   
   In the view of the author, following mercantile system of accounting would be easier & better as it will avoid the complications of reconciliation, TDS credit and would result in even distribution of income over different years. It may also result in avoidance of unwanted notices from the income tax department as TDS entries would b e reflected in AIS/26AS on accrual basis.