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Don’t lose sight of the good old NSC
Finance - Small Savings

The returns are not only assured, but also tax-free, and with a govt guarantee

The National Savings Certificate (NSC) may appear to have lost out to the melee of investment options including equities, mutual funds, unit linked insurance plans and fixed maturity plans in terms of popularity. But, there is no ignoring the instrument’s respectable returns, which are not only assured, but also tax-free and come with a government guarantee.

Compared with the NSC, the Public Provident Fund (PPF) has always been more popular on account of its 8% tax-free interest. However, PPF suffers from a maximum ceiling of Rs 70,000 per annum. In other words, the maximum amount one can invest in PPF every year is capped at Rs 70,000.

In NSCs, however, there is no limit to how much one can invest. What’s more, interest up to Rs 1 lakh is tax-free. Yes, you read that right. NSCs offer you the possibility of earning up to Rs 1 lakh fully tax-free.

This is because NSC is the only small saving scheme wherein not only the initial deposit, but also the interest for the first five years, out of its term of six years, is eligible for a deduction under section 80C. This point is clarified later on in the article. But first, let’s understand the basic features of this instrument.

NSC offers 8% interest compounded half-yearly. Consequently, the effective rate per annum works out to 8.16%. It is a cumulative scheme with a term of six years. In other words, though the interest accrues every year, it is paid to the investor together with the initial capital invested at the end of six years. For example, Rs 10,000 invested in NSC today will grow to Rs 16,010 at the end of six years. As mentioned earlier, the net effective rate of return works out to 8.16% p.a.

In order to optimally use this instrument, it is very important to understand the tax treatment of the interest paid. Unlike PPF, wherein the full amount of interest is completely tax-free, NSC interest is actually taxable. However, since it is a cumulative scheme (where the interest is not paid to the investor but instead accumulates in the scheme), each year’s interest (for the first five years) is deemed to be reinvested in the NSC. Since it is deemed reinvested, it qualifies for a fresh deduction under Sec 80C, thereby making it tax-free. Only the last year’s interest, when the NSC matures, does not get a tax deduction as it does not get reinvested, but is paid back to the investor along with the interest of the earlier years and the capital amount.

Let’s understand this feature in terms of an example. Say, you invest Rs 1,00,000 in an NSC on April 1, 2008. Interest on this investment for each year is contained in the following table:

April 1, 2008 Initial inv 100,000
Mar 31, 2009 Int for Yr 1 8,160
Mar 31, 2010 Int for Yr 2 8,830
Mar 31, 2011 Int for Yr 3 9,550
Mar 31, 2012 Int for Yr 4 10,330
Mar 31, 2013 Int for Yr 5 11,170
Mar 31, 2014 Int for Yr 6 12,070
Total interest60,110
Total value of investment1,60,110

Now, the interest amounts for each year (Rs 8,160, Rs 8,830, Rs 9,550 and so on) are not actually paid to you but instead accumulate in the scheme. Since they so accumulate, they are deemed to be reinvested and hence qualify for the Sec 80C deduction. It is only the sixth year’s interest that doesn’t get reinvested and hence is fully taxable.

To benefit from this feature of reinvested interest and the consequent deduction, it is important to declare the accrued interest on NSC on a yearly basis in your tax return. In terms of the above example, for FY 08-09, you will include the interest amount of Rs 8,160 in your tax return under the head Income from Other Sources. At the same time, under deductions, you will claim Rs 8,160 under Sec 80C as reinvested NSC interest. Both cancel each other out, making the interest in effect tax-free.

Now for another small but important detail. From the above discussion, it is clear that both NSC as well as PPF interest is tax-free. However, the difference is that PPF interest is tax-free per se, whereas the NSC interest becomes tax-free on account of the deemed reinvestment under Sec 80C. Readers would know, however, that Sec. 80C has a limit of Rs 1 lakh. So, your NSC interest would only qualify for the deduction provided you have room left in Sec 80C. As it is, provident fund contributions, insurance premiums, housing loan principal repayments, tuition fees, PPF, tax saving mutual funds and bank deposits —- not to mention any fresh investment in NSC —- all of these are also covered under the same Rs 1 lakh limit. So, if you intend to invest and take advantage of the tax-saving feature of NSC interest, remember to make the necessary adjustment so far as the other tax-saving investments are concerned.


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