Why bank depositors deserve tax-free interest
Bank depositors suffer from poor service and problems of getting TDS certificates on time, whereas a tiny part of the population enjoys tax-free dividends and capital gains from stocks. Here is a suggestion to make it fairer for bank depositors
 
The bank depositors are the pillars of strength for the commercial banks, but they are the most harassed, most repressed and deprived. They don’t get the service they have a right to expect, they don’t get the right product they need, they don’t get the right price for their deposits and they don’t get the respect they deserve for the deposit support they provide, which is the basic raw material for banks to make profits. 
 
The worst part of banking is the negative return they provide to the depositors, who in the interest of safety of their hard earned savings place implicit faith in the banks and silently suffer erosion in their savings without realizing the loss they incur year after year. The high rate of inflation and the rising cost of living have created a deep dent on their savings. This is made worse by tax laws, which are regressive on account of the failure of the government to bring inflation under control. 
 
As against these inflation figures, interest rates on deposits during the above period ranged from 8.00 to 8.50 % per annum for one year deposits, which is lower than the inflation, which means it is a negative real rate of return for the depositors. There are about 500 million people in this country with bank accounts and at least half of these account holders may have term deposits in some form or other. Inflation is a hidden tax on such a vast number of people, who bear this burden without even realizing it till it bites them severely. The most awful part is that people have to shell out income tax on the interest earned on bank deposits at the rate ranging from 10% to 30% depending upon the total taxable income of each individual. This virtually results in double taxation on poor and middle class people, who form the majority of honest tax payers in our country. 
 
As a result it is driving the common man to invest in unreliable ponzi and money-multiplier schemes, which are thriving at the cost of the not-so-financially-literate middle class and lower middle class, who together constitute about half the country's population. 
 
As if this agony is not enough, all these bank depositors who honestly pay taxes on the interest received from banks on their deposits, have been suffering in silence for the past several years, because, day by day, they find it difficult to get TDS certificates from these banks, who simply do not bother to give the certificates on time. In the month of July every year, people have to run from pillar to post to get TDS certificates from their banks, to enable them to file their tax returns on time. 
 
The paradox of earned and unearned income:
India is a tax haven for the rich as they do not have to pay any tax on their investment income, because the dividend income is totally tax free at the hands of the shareholders and capital gains on stock market investments are either tax free or taxed at lower rate of taxes. As per the press reports the aggregate dividends earned by business houses during 2010-11 was Rs48,191 crore on which no tax was required to be paid. The Tata group dominated the business houses and its 29 group companies together paid Rs3845 crore as dividend to the holding company, on which holding company did not have to pay any tax.
 
Here is a list of top ten individuals whose dividend income runs in to crores of rupees, which are totally tax free under the existing laws in India. 
 
 
It is ironical that a common man in India has to pay income tax if his/her total income including interest on bank accounts crosses the basic exemption limit of Rs2,00,000 per year, that is just a paltry sum of Rs16,660/- per month, which is  inadequate even for a small family to make a bare subsistence living. And if he places his hard earned savings in fixed deposit with banks, income tax gets deducted at source from the interest received on these deposits, even before he receives any interest from the bank. 
 
Citizens who depend on bank interest: 
Bottom of FormThe anguish and anxiety of bank depositors who almost wholly depend on the interest received from banks for their livelihood, is only to be experienced to be believed. To save themselves from the burden of TDS, they are required to submit form 15G or15H to the banks concerned, at the beginning of every year, if their total income for the year is within the exempted limit prescribed under the Income-Tax Act. And this form is required to be submitted every time they make a fresh deposit with the bank, which is both wasteful and cumbersome. 
 
The common experience of many of the citizens has been that such forms submitted by them many times, either gets misplaced at the bank's branches or are not properly noted in bank's records, due to which tax gets deducted at source, forcing them to undergo the rigmarole of filing income-tax returns to claim refund of tax that has been wrongly deducted, as banks refuse to refund such wrong deductions.
 
These are the woes of bank depositors in India who receive a raw deal from the commercial banks because they do not have anybody to champion their cause. The government is keen to expand the reach of banks in unbanked areas propagating financial inclusion, but has done precious little to incentivise savings through the banking system. 
 
There is an urgent need, therefore, to find a lasting solution to this double whammy faced by the hapless depositors, who form the backbone of the country's banking system. The only plausible solution to free millions of our country men and women from this agony and suffering caused by the irritating provisions of the tax laws and the complex systems of compliance is to make the interest paid by the commercial banks on all their deposit accounts tax-free at the hands of the recipients. And this can be achieved without hurting government coffers, if the following suggestion is implemented by the Finance Minister in right earnest. 
 
In the Finance Act 2003, the then finance minister announced a bonanza for corporate investors. By a stroke of the pen, he abolished income-tax on dividends declared by domestic companies and approved mutual funds, and made it totally tax-free in the hands of shareholders and mutual fund investors from 1 April 2003. This was a great boon to the investors in the stock market, who unfortunately form a microscopic minority in our country. This step mainly helped corporate bigwigs, the high and the mighty, the rich and the wealthy and high net-worth individuals, who have invested in the stock market and reaped the rewards of tax-free income. Now, there is no TDS, no income-tax and no harassment of investors in the stock market. 
 
In order to compensate the government for the loss of revenue caused by this tax-free dividend, the finance minister introduced simultaneously the dividend distribution tax, to be paid by companies paying dividends to their shareholders. This move worked to the advantage of the government, who got taxes paid in the beginning of the year directly from the companies, when the dividends are declared, instead of collecting in piecemeal from the shareholders throughout the year. 
 
Subsequently, the government totally abolished income tax on long term capital gains earned on stock market investments held for more than one year and in its place introduced securities transaction tax at nominal rate for all stock market transactions done through the recognized stock exchanges. 
 
While these steps no doubt benefited the rich and the high net worth individuals, it touched only a fringe of the population. It would be only fair to extend the same principle to millions of individuals (not businesses or corporates) covering the middle and the lower middle class by declaring the interest received from the scheduled commercial banks upto a certain level free of income-tax at the hands of the recipients, thereby providing much-needed relief to the large body of bank customers and depositors, who have been at the receiving end of the blow caused by rising inflation and poor customer service provided by the banks. This is nothing new considering that all non-resident and foreign currency deposits held by NRIs are already tax-free at present and it is only the extension of such a provision to domestic deposits as well, which will put resident Indians at par with non-residents. 
 
How to recoup the loss of revenue to the exchequer?
In order to bridge the budgetary deficit that might be caused by this step of freeing bank deposits from income-tax, the finance minister can consider levying interest payment tax on commercial banks at a very nominal rate, to be paid by banks along with the advance income-tax remitted by them every quarter. This interest payment tax, based on the total interest outgo of each bank, on the lines of the dividend distribution tax but at a fraction of this rate, will be the best substitute for the tax presently levied on each deposit kept with the banks. This extra burden on banks can be easily absorbed by them as this will help the banks to considerably improve their deposit base due to tax-free benefits available on bank deposits and will help them to increase profitability too, by substantially increasing their lending operations.
 
The benefits of this exercise for the people, the government and the banks, when implemented, can be summarised as under: 
  1. The biggest relief will be for the common man who has been suffering from the burden of high inflation and poor customer service from banking institutions. 
  2. The economy will get a boost as the savings rate will shoot up considerably due to bank deposits becoming an attractive investment destination for the common man who will not fall a prey to ponzi schemes and the like. 
  3. The financial inclusion programme of the RBI will get a shot in the arm as banking will be hassle-free, tax-free and free from the complexities of taxation laws for all those who are brought into the banking system.
  4. The banks in the country will be the biggest beneficiaries with bank deposits becoming the most attractive investment avenue for the public, and banks would be flooded with deposits, which through judicious lending will improve their profitability considerably. 
  5. Due to the tax-free status of bank deposits, people in rural areas will be attracted to banks to invest their surplus funds, thereby serving the cause of rural population admirably and banks will be keen to open more branches in rural areas, which will benefit both the banks and the rural people. 
  6. There are more than 1,10,000 branches of banks in India today and they will be saved from the burden of deducting taxes every now and then and filing innumerable returns to several authorities, thereby saving time, energy and money for the banks in the country. 
  7. The government, in turn, will benefit from getting taxes directly from banks in one go, helping the government treasury with better cash flow and improved management of funds. 
  8. The income tax department will be saved the burden of processing millions of small value tax returns and dispensing refunds thereby, saving on cost of operations and improving efficiency.
If this proposal is implemented on the lines suggested above, this will be one of the most people-friendly measures from any government in power and will go a long way to earn the trust and confidence of millions of people without any loss of revenue to the government. This is the best way in which the new central government in the country can create a new paradigm shift in the banking industry and serve to meet the expectations of over a billion people of this country, who are waiting for economic revival with social justice. 
 
(The author is a banking analyst and he writes for Moneylife under the pen name 'Gurpur'.) 
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