Depositors of Punjab & Maharashtra Co-operative (PMC) Bank are in for a double whammy. On the one hand, they are unsure if they would get back their money. On the other, the bank is deducting withholding tax or tax deducted at source (TDS) at 10% on the interest these depositors would have earned if the bank were fully functioning. Banks need to deposit TDS with the tax department.
Even though the depositors may not get back their money entirely, they will need to pay tax on the interest they would have earned on their deposits with PMC Bank.
Typically, banks deduct 10% tax on the interest earned by a depositor, which is reflected in Form 26AS. The depositor then must calculate the applicable tax based on the slab rate and pay it when filing returns. For example, a depositor in the 30% slab would have to pay another 20% of the interest as tax.
However, the phenomenon is not unique to PMC Bank. Depositors of cooperative banks and even deposit-taking non-banking financial companies (NBFCs), which are under Reserve Bank of India (RBI) restrictions, could face similar issues.
Whenever banks or deposit-taking NBFCs are seen as mismanaging operations, RBI disallows depositors to withdraw money from their accounts or make any payments. The Banking Regulation Act gives the regulator powers to take action if it feels that the lending institution is not acting in the interest of the depositors.
In many cases, RBI has imposed such restrictions on banks for years as it has tried to find a resolution in the interim. Until such financial institutions are merged with another one or are liquidated, depositors are always unsure how much money of their total deposits they would get back.
Impact on depositors
Some tax experts feel that deduction of tax on deposits is a procedural requirement that needs to be carried out and is beneficial for depositors. “Banks are right in deducting tax on the interest accruing on the fixed deposits placed by its depositors. It is liable to pay such interest to the depositors even though it is presently restricted from making payment to depositors,” said Sonu Iyer, tax partner and people advisory services leader, EY India, a tax audit and consultancy firm.
If a bank is crediting interest in its books in favor of depositors, it is legally liable to deduct tax on such interest. The depositor gets to know that the interest is credited. The amount of tax deducted can be seen in the TDS certificate through Form 16A and Form 26AS.
This way, if the interest income is not liable to tax, the depositor may file Form 15G (or 15H for senior citizens) along with the supporting documents and request the bank not to withhold any tax on the interest income. The two forms apply to investors whose taxable income is nil—up to ₹5 lakh at present considering the ₹12,500 tax rebate.
However, there is a flip side too. Depositors who are not business owners must pay tax on the interest income even though they may not have access to their money. “Tomorrow if a bank is liquidated or the depositor gets only a part of the money he has kept with the bank, there is no provision to claim back TDS,” said Naveen Wadhawa, deputy general manager, Taxmann.com, a platform that provides tax research-related services. Besides TDS, the ones in higher tax brackets will also lose out on the additional tax they would have paid, since TDS banks only deduct tax at 10%.
What if you don’t pay tax on the notional interest that the bank credits into your account? “At the time of processing the income tax returns (ITR), the tax department could raise a question or make an adjustment if the ITR does not match with Form 26AS. In that case, an appropriate response explaining the tax position will need to be submitted by the taxpayer,” said Shailesh Kumar, partner, Nangia & Co. LLP, a tax audit and consultancy firm.
If Form 26AS reflects TDS, you will need to pay tax on the deposit that you may or may not get in the future. If your distressed financial institution is not deducting TDS, check with your chartered accountant if you need to pay any tax.