Interest on Securities

An interest in securities is the asset of a client for whom an intermediary holds security on an unallocated basis, commingled with the interests in securities of other clients. The distinction between securities and interests in securities is often overlooked in practice.

Interests in securities are always intangible. The only evidence of them comprises electronic records. Interests in securities confer property rights in relation to the underlying securities, and in some cases, these underlying securities comprise tangible bearer instruments. However, this does not mean that interests in securities are themselves tangible. They are unallocated, and therefore do not attach to any tangible asset.

In income-tax parlance, security is a document possessed by the creditor as a guarantee for the payment indebted to him. Interest on securities refers to any of the following types of income:

• Interest on any security which has been issued by the Central Government or State Government.
• Interest on debentures or other securities for money issued by on or behalf of a local authority or a company/co-operation established by a Central, State or Provincial Act.

Basis of Charge

If the assessee maintains books of account on a cash basis, interest by way of interest on securities is taxable on receipt basis. If the books are being maintained on the mercantile system, it is taxable on due basis. It is again taxable on receipt basis if such interest had not been charged to tax on the due basis for any earlier previous year.

Due Date of Interest

Interest on securities does not accrue on a daily basis or according to the period on which investment is held. It becomes due on the due dates specified on securities.

Interest Exempt from Tax

Interest on notified securities, as well as notified bonds and certificates, are fully exempt from tax. Also, interest on Post Office savings bank account is exempt up to an amount of Rs 3,500 with respect to an individual, and Rs 7,000 in the case of a joint account.

Grossing up of Interest

Grossing up mechanism specifies that the payer must ensure complete payment of the amount due to the recipient, which precisely means that the payer must cover the tax deduction costs of the payee.

Gross interest, which is derived after adding net interest with tax deducted at source, is taxable. Net interest is grossed up in the hands of the recipient if the payer deducts tax at source. Net interest is grossed up by using the following formula:

100/ (100 – Rate of tax deduction at source)

Avoidance of Tax

As already discussed, interest on securities does not accrue on a daily basis, but on certain stipulated dates. Given this scenario, there might be instances where a person transfers securities to another person on a few days or even the evening prior to the due date and reacquires the same or similar securities after the receipt of interest by the transferee. This would enable the transferor to evade tax in respect of such interest. Such a transaction is popularly known as a bond washing transaction. The following measures have been suggested to prevent tax avoidance:

When Income Belongs to the Transferor

Section 94(1) of the Income-tax Act provides that, if a security owner transfers the securities on the eve of the due date of interest and acquires them back at a later point of time, the interest received by the assessee will not be a part of the assessee’s income, but the transferor’s, thereby forcing the transferor to remit his/her tax dues.

When Tax is Avoided through Sale of Interest-bearing Securities

Other than what is known as a bond washing transaction, sale of securities cum-interest is another method of avoiding tax. Selling of sales cum- interest refers to a situation where an assessee, who holds a beneficial interest in securities during the previous year, sells them in a manner that either no income is received or income received is lesser than the sum he would have received if interest had accrued on a daily basis. In this case, income from securities for the particular year would be deemed as income of such person. The aforementioned anti-avoidance measures are not applicable if the owner of securities proves to the satisfaction of the Assessing Officer that there has been no avoidance of income tax or the avoidance of income-tax was exceptional and not systematic, and hence there was not any avoidance of income-tax.

Section 194A of the Income Tax Act

It describes and lays out the provisions under which TDS will be applicable for deduction on interest incomes or payments on anything but securities.

Following are some of its salient features:

• TDS is deductible on interest against fixed deposits, recurring deposits, loans and advances of both a secured (for instance, against collateral) and unsecured nature.
• TDS Deductible on interest against securities are also considered under the TDS rules; however, the provisions with respect to that are covered under Section 193 of the Income Tax Act.
• This section is only applicable to the residents of India. Hence, all the provisions are not applied to Non-Resident Indians.
• Payments made to NRIs are also subject to TDS deductions, but that portion is covered in Section 195 of the Income Tax Act.
• In case an individual or an entity is not liable to pay taxes since their incomes do not exceed the minimum income slab which is taxable as per the government regulations, the respective entities can submit a copy of either Form 15G (for resident Indians under the age of 60 and Hindu Undivided Families) or Form 15H (for resident Indians either turning 60 during the Financial Year or who have already turned 60) to the payer of the interest.

The following persons are required to deduct TDS according to section 194A:

• An individual or a Hindu Undivided Family provided that under and as per Section 44AB of the Income Tax Act of 1961, they are liable to get their accounts audited by a Chartered Accountant. Other individuals and Hindu Undivided Families are exempted from these provisions of Section 194A of the Income Tax Act.
• All other entities described as “assessees” by the Income Tax Act of 1961, such as a Partnership, a Company, an Association of Persons (AOP) or a Body of Individuals (BOI).

The following persons are required to deduct TDS according to section 194A:

• This type of income tax is to be deducted by the entities described above, either at the time of payment of interest thereof in either cash, cheque, draft or any other mode, or when the said interest payment is credited to the account of the individual receiving the tax, whichever is earlier.
• In the cases in which such interest is credited to accounts such as Interest Payable Accounts or Suspense Accounts or any other accounts, conditions laid down under Section 194A shall apply and TDS will have to be deducted.

No TDS is to be deducted for interest payable on the following bonds / securities:

• Interest on 7 year National Savings Certificate (IV issue).
• Interest on the National Development Bonds.
• Interest on 4.25% National Defence Loan, 1968 or National Defence Loan, 1972 held by an Individual.
• Interest on 4.25% National Defence Bonds, 1972 held by a resident Individual.
• Interest on Security of the Central Government or a State Government provided the interest amount doesn’t exceed INR 10,000.
• Interest on 6.5% Gold Bonds, 1977 or 7% Gold Bonds, 1980 held by a resident Individual only if the total nominal value of the bonds didn’t exceed INR 10,000 at any time during the period to which the interest relates.
• Interest on debentures to a resident individual or HUF provided the aggregate amount of interest doesn’t exceed INR 5,000, and the interest is paid by cheque.
• Interest on debentures issued by notified institution/authority/public sector company/a co-operative society.
• Interest to the Life Insurance Corporation on the securities owned by it or in which it has a full beneficial interest.
• Interest to the General Insurance Corporation on the securities owned by it or in which it has a full beneficial interest.
• Interest to any other insurer on the securities owned by it or in which it has a full beneficial interest.
• Interest on securities only if issued by a company in dematerialized form and listed on the recognized stock exchange.

Exemption limit under section 193 of income tax act

There is no exemption limit specified in case of TDS under section 193 except two following cases;

• In the case of debentures issued by listed companies the limit is Rs. 5000 provided such amount should be given by an account payee cheque. And
• In case of 8% saving (taxable) bonds the limit is Rs. 10, 000.