Maximising interest income from investments

S. R. Balachandran

When we deposit money in Treasury Bills, Banks and Financial Institutes, we receive interest. With effect from 2002/2003 withholding Tax of 10 percent was introduced on the interest income. Several amendments have been subsequently effected to rectify certain anomalies.

At present the Withholding Tax procedure is as follows:

a. If an individual gives a declaration to a bank or financial institute, that his total annual income (employment, deposits, other sources etc) is less than Rs 300,000 no tax is deducted.

b. If the income exceeds Rs 300,000 up to the limit of one million a withholding Tax of 2.5 percent will be deducted on the interest.

c. If the total income interest exceeds one million tax will be deducted at the rate of 10 percent.

The following factors should be considered:
1. The interest on which Withholding Tax has been deducted is tax free.
2. Income from Treasury Bills is also tax free and it is not counted when computing total income for withholding Tax purpose by a Bank or Finance Institutes.
3. If a person is 59 years old on April 1 of any year of assessment he is entitled to an additional exemption for Rs 200,000 provided he makes deposits in selected Government banks.

Individuals should carefully allocate their funds to enjoy tax exemptions. For example if a person's interest from a bank is Rs 600,000 per year the withholding Tax would be Rs 15,000 (2.5 percent). If he receives the entire Rs 600,000 from Treasury Bills it is tax free.

If he receives Rs 300,000 Treasury Bill income and Rs 300,000 from Bank deposits again it is tax free. If his income is Rs 1,100,000 the withholding Tax would be Rs 110,000.

If he receives the entire income from the Treasury Bills it is tax free. If he receives One Million from a Bank as interest and the balance from the Treasury Bills only Rs 25,000 would be deducted.

Therefore if allocation is made professionally tax benefit could be maximized. At present the income from Treasury Bills is low (8 percent). A Bank may offer interest rate more than 8 percent. I quote below the following cases:

1. Treasury Bill income and Bank interest are same
2. Treasury Bill income is more than Bank interest
3. Bank interest is more than Treasury Bills income but within the range of 2.5641 percent. i.e. if the Treasury Bill income is 8 percent the Bank interest is within 8.205 percent.
4. Bank interest is more than Treasury Bill income but within the limit of IT. 11 percent i.e. if the Treasury Bill income is 8 percent the bank interest is more than 8.205 percent (say 8.5 percent) but within 8.89 percent.
5. Bank interest is more than Treasury Bill income by 11.11 percent i.e. Treasury Bill is 8 percent Bank Interest is more than 8.89 percent.

Now deposit allocation is as follows:
a. In the first case mentioned in the above deposit all your funds in Treasury Bill
b. In the second case mentioned in the above deposit all your funds in Treasury Bill
c. In the third case
Up to Rs 300,000 income deposit in Bank
If it exceeds Rs 300,000
First Rs 300,000 income from Bank
Balance from Treasury Bills

Even if the income exceeds one million this procedure is applicable.
X = 8.00 percent (say)
Y = 8.20 percent (say)

d. In the fourth case where the bank interest is more than 102.564 percent of Treasury Bills income you have to compute Break Even Interest using Mathematical formula details of which are quoted separately.

Up to first Rs 300,000 place it in the bank. When it exceeds Rs 300,000 but within Break Even Interest place the excess investment in Treasury Bills.

If the interest is more than Break Even Interest up to Rs one million place the entire

deposit in the bank (No Treasury Bills)

If the income exceeds Rs One Million

Up to Rs one million place it in bank

Balance in Treasury Bills

Now I quote below the method of computing Break Even Interest
Treasury Bills income X% - 8.00% (say)
Bank Interest Break Y% - 8.50% (say)
Even Interest 1% - 521,740* (see the computation below)

I (100 - 2.5) - 300,000 x 100
----- --
Y Y - X Y

e. In the Fifth case Bank Interest is more than 11.11 percent of Treasury Bills new Break Even Interest has to be computed using new formula in addition to old formula.

I
"100 - 7.5
-- -- 1,000,000 X 100
Y 97.5 Y-X --
----- Y
100
X = 8.00% (say)
Y = 9.00% (say)
I = 7749955 (See the computation above) and 387096 (old formula)

Up to Break Even Interest - Bank interest 300,000 and balance in Treasury Bills only Above Break Even Interest to 1,000,000 - Bank interest only (No Treasury Bills) Above 1,000,000 up to second Break Even Interest - Bank Interest up to 1,000,000 Balance Treasury Bills only.

Above second Break Even Interest Bank Interest only.

Now we have to consider the case where the investor is having other income as well (employment and other sources). Let this be called "A".

The following allocations have to be made:
1. In the case One no change - entire deposit in Treasury Bills
2. In the case Two no change - entire deposit in Treasury Bills
3. In the case Three there is no Break Even Interest. (A would be more than 300,000) (see the formula below)

I (100 - 2.5 = (300,000 -A) x 100
-- -- --
Y Y-X Y

Up to total interest of 300,000 Bank Deposits only. Beyond which the balance in Treasury Bills only.

4. In the case Four new Break Even Interest has to be computed according to the same formula (A would be less than 300,000)

X = 8.00 (say) Y =
8.50 (say) A =
200,000 (say)
1 = 173,913 - I 100 - 2.5 = (300,000 - 200,000) x 100
-- -- --
8.50 8.50 - 8.00 8.5

Up to the total income of 300,000 (employment, deposits and other sources) only bank deposits are possible.

From 300,000 to the total income of Break Even Interest and other income place Excess Investment in Treasury Bills.

Thereafter up to one million (total income) entire deposits in Bank. Balance over and above one million in Treasury Bills.

5. In the case of Five, Break Even Interest should be computed using second formula

I 100 - 7.5 = (1,000,000 - A) X 100
-- -- --
Y 97.5Y - X Y
---
100

X = 8% (say)
Y = 9% (say)
A = 700,000 and 200,000
I = 2324986 (see the computation above) and 129032 (Old formula)
6201392 (New formula)

-------
Interest Income 400,000 521,740 700,000 1,000,000 1,100,000
Tax Rate 2.5% 2.5% 2.5% 2.5% 10%
Interest Income 390,000 508,696 682,500 975,000 990,000
after tax
Total Investment 9,705,882 6,138,118 8,235,294 11,764,705 12,941,176
Investment in Bank 3,529,412 3,529,412 3,529,412 3,529,412 11,764,705
Investment in 1,176,470 2,608,706 4,705,882 8,235,293 1,176,471
Treasury Bills
Income from Bank 300,000 300,000 300,000 300,000 975,000
Income from 94,117 208,696 376,470 658,823 94,117
Treasury Bills
Total 394,117 508,696 676,470 958,823 1,069,117
Interest after tax 390,000 508,696 682,500 975,000 990,000
as mentioned above
Difference 4,117 - (6,030) (16,177) 79,117

Interest Income 400,000 700,000 1,009,001 1,100,000
Tax Rate 2.5 2.5 2.5 10
percent percent percent percent
Interest Income after tax 390,000 682,500 975,000 990,000
Total Investment 4,878,048 8,536,585 12,195,122 13,414,634
Investment in Bank 3,658,536 3,658,536 3,658,536 3,658,536
Investment in Treasury Bills 1,219,512 4,878,049 8,536,586 9,756,098
Income from Bank 300,000 300,000 300,000 300,000
Income from Treasury Bills 97,561 390,243 682,926 783,487
Total 397,561 690,243 982,926 1,080,487
Interest after tax as mentioned above 390,000 682,500 975,000 990,000
Difference 7,561 7,743 7,926 90,487

Interest Income 100,000 173,913 200,000 800,000 1,000,000
Tax Rate - 2.5 2.5 2.5 10 percent percent percent percent
Interest Income 100,000 169,565 195,000 780,000 900,000 after tax
Total Investment 1,176,470 2,046,035 2,352,941 9,411,764 11,764,705
Investment in 1,176,470 1,176,470 1,176,470 1,176,470 9,411,764
Bank
Investment in - 869,565 1,176,470 8,235,294 2,352,911
Treasury Bills
Income from Bank 100,000 100,000 100,000 100,000 780,000
Income from - 69,565 94,117 658,823 188,235
Treasury Bills
Total 100,000 169,565 194,117 758,823 968,235
Interest after tax 100,000 169,565 195,000 780,000 900,000 as mentioned above
Difference - - (883) (21,177) 68,235