Premature encashment of FD’s and impact on Income Tax

Premature Encashment of Fixed Deposits – An important judgment helpful during the extreme hardships of the COVID 19 pandemic.

Globally, COVID 19 has caused extreme hardships both financially and physically and a significant population of the world is suffering due to this pandemic. There is a war between the human race and the virus. India is also a vicious sufferer of this deadly virus. The constant struggle of people to maintain a living and keeping the homes running has made a hole in people’s pockets. People are using their liquid savings and turning to encashment of assets for arranging money. This judgment is quite useful for people turning to their Fixed Deposits and making premature withdrawals.

Generally, banks pay a lower rate of interest in case of premature withdrawal and charge a penalty of 1% which puts a significant burden on people. Moreover, the amount reflected in Form 26AS is more than the actual interest received because of the withdrawal of Fixed Deposits during the fag end of the year. The net interest received will accordingly be chargeable to tax and deduction can be claimed for the excess amount.

Section 71 of the Income Tax Act, 1961 defines that where the assessee has suffered a loss under any head of income other than capital gain and has income under any other head including capital gain head, he can set off the loss under such head of income. However, this does not apply to loss under the head Capital gain which can only be set off against the same head.

As explained in the case law below, if the assessee suffers any expense in nature of penalty, premature charges or withdrawal charges, fees of any kind, these will be allowed under any head which has income chargeable to tax. This applies equally to Income from Other Sources as to business Income, as in the case as described above the income was not chargeable to tax under the head business income as he was not in the business of loans and investment but the business of making bidis, still it is allowed to set off the loss/expense of premature withdrawal under any other head or same head of Income.

In the wake of the COVID 19 pandemic, a lot of people are forced to turn to their Fixed Deposits and making premature withdrawals on which banks charge huge fees in the nature of premature withdrawal charges. Though the hardship in form of these charges can’t be undone but these charges are allowable under the Income Tax Act so at least a small part of these charges needn’t be borne by the Assessee them selves and will be, if not huge, a little sigh of relief for the concerned people. A relevant case law is given below for ready reference.

Madhya Pradesh High Court in Commissioner Of Income-Tax v. Purushottamdas Dhoribhai And Co. on 4 September, 1996 Equivalent citations: 1997 226 ITR 579 MP : 1. This is an income-tax reference under Section 256(1) of the Income-tax Act, 1961 (for short, the Act), and the following questions of law have been referred by the Tribunal for answer by this court :

1. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law to hold that the Assessing Officer/Department, had accepted the position that the income from fixed deposits receipt, was assessable under the head ‘Business’ on accrual basis ?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law to hold that the findings of the Commissioner of Income-tax (Appeals) that interest on fixed deposits receipts was assessable under the head ‘Other sources’ is not correct ?

3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the interest income amounting to Rs. 71,013 taxed on accrual basis and subsequently claimed as deduction is admissible under law ?”

2. The assessee is a registered firm which derives its income from manufacture and sale of bidis. The assessee earned interest from bank deposits in the shape of fixed deposit receipts which was not part of the assessee’s business. During the year under consideration, the assessee claimed deduction of Rs. 71,013 on account of the fact that in the earlier year, the assessee had purchased fixed deposit receipts out of its capital. It was assessed on interest on these fixed deposits receipts on accrual basis from year to year. The fixed deposit receipts were got encashed prematurely and, as such, interest, already taxed on accrual basis, amounted to a loss. Therefore, it was claimed as a deduction. The Assessing Officer also disallowed the claim stating that there was no provision in the Act to allow such deduction. Aggrieved by this order, the assessee approached the Commissioner of Income-tax who upheld the order of the Assessing Officer holding that the interest income from fixed deposit receipts even on accrual basis is assessable as income from other sources and, as such, the claim for deduction was not allowable either under Section 57 or Section 58 of the Act. Aggrieved by this order, the assessee approached the Tribunal which decided the matter in favour of the assessee and granted deduction of the aforesaid sum. Hence, the Department approached the Tribunal for referring the matter before this court and, accordingly, the Tribunal has referred the aforesaid three questions for answer by this court.

3. We have heard learned counsel for the parties and perused the record. On the basis of the admitted facts, the question for consideration is whether the loss of income caused to the assessee on account of premature encashment of the fixed deposit receipts can be made good under the provisions of the Act or not.

4. Though no provision of law was referred by the Tribunal, nor was it brought to the notice of the Tribunal, Shri Nema, learned counsel for the assessee, has invited our attention to Sections 70, 71, 72 onwards. Section 70 deals with the set-off of loss from one source against income from another source under the same head of income, Section 71 deals with set-off of loss from one head against income from another. Section 72 deals with the carry forward and set-off of business losses. The Tribunal, of course, did not make a specific reference to the provision of law. However, the Tribunal observed in the order that in this case interest was not received in the year the assessee was assessed on its accrual basis. Therefore, it was found that once the Department accepted the position that income from the fixed deposit receipts was assessable under the head “Business” on accrual basis, then the loss suffered by the assessee on account of premature encashment of fixed deposit receipts will have to be allowed as a deduction, but it is not pointed out under which law.

5. The finding of the Tribunal that it is a business income is also not correct. In fact, the assessee is doing the business of manufacture of bidis and not dealing with the business of investment and loans. Therefore, it can, at best, be treated to be an income from other sources. Be that as it may, that would not make much difference. However, Section 71 provides that such kind of losses can be set off if the income under the same head is not assessable from income of another head. Section 71 reads as under :

” 71. Set off of loss from one head against income from another. -(1) Where in respect of any assessment year, the net result of the computation under any head of income, other than ‘Capital gains’ is a loss and the assessee has no income under the head ‘Capital gains’, he shall, subject to the provisions of this Chapter, be entitled to have the amount of such loss set off against his income, if any, assessable for that assessment year under any other head.

(2) Where in respect of any assessment year, the net result of the computation under any head of income, other than ‘Capital gains’, is a loss and the assessee has income assessable under the head ‘Capital gains’, such loss may, subject to the provisions of this Chapter, be set off against his income, if any, assessable for that assessment year under any head of income including the head ‘Capital gains’ (whether relating to short-term capital assets or any other capital assets).

(3) Where in respect of any assessment year, the net result of the computation under the head ‘Capital gains’ is a loss and the assessee has income assessable under any other head of income, the assessee shall not be entitled to have such loss set off against income under the other head.

(4) Notwithstanding anything contained in Sub-sections (1) and (2), where in respect of any assessment year the net result of the computation, in relation to any property (other than the property referred to in Sub-clause (i) of Clause (a) of Sub-section (2) of Section 23) under the head ‘Income from house property’ is a loss and the assessee has income assessable under any other head of income, the assessee shall not be entitled to have such loss set off against income under the other head.”

6. Therefore, in the present case, the deduction of Rs. 71,013 allowed by the Tribunal is well justified as the assessee has suffered loss on account of premature encashment of the fixed deposits receipts and such set-off is permissible under Section 71 of the Act.

7. Accordingly, we are of the opinion that the Tribunal was justified in allowing the relief of Rs. 71,013 to the assessee. We, accordingly, answer all the three questions in favour of the assessee and against the Revenue.

I hope the above case law and principle will be helpful to readers.