Is interest from income tax refund taxable?

Be it because of poor tax planning or poor financial planning, you may end up paying more tax than what is required. Your employer might ask you to declare the tax-saving investments planned for the year at the year’s beginning to make sure that the correct tax is deducted each month. But, this leads to over-taxation if you end up under-reporting the amount. In such cases, you become eligible for a tax refund. Under some circumstances, the refund amount becomes eligible for interest. Is interest on income tax refund taxable? Let’s find out:

Yes, the interest from the income refund is taxable.

Let’s understand when a refund earns interest. If the refund amount is at least 10 percent of the actual tax liability before TDS, then the refund is eligible for simple interest.

Let’s understand this using an example. Let’s say your actual liability was ₹50000 but you paid ₹75,000 as tax. Here, the excess tax paid of ₹25000 (75000 – 50000) is more than 10 percent of the actual amount to be paid [(25000/50000)x100 = 50 percent].

Now, you are eligible for a tax refund as well as a simple interest of 0.50% per month, or 6.0% p.a. Now, let’s say the refund, as well as the interest, was paid at the end of Jan. 2014. Here, the interest amount will be 1250 (25000x0.50%x10 months). Only this interest amount will be taxable. So, if you are in the 10% tax bracket, you’ll have to pay 125 as a tax on the interest on the refund.

The interest amount that you pay back falls under “income from other sources". So, while filing returns for the F.Y. in which the refund was provided, the interest will be taxable as per your tax slab rate. Let’s say, in the F.Y. ending Mar. 2013, excess tax was paid and the refund was made in the F.Y. ending Mar. 2014. While filing returns for F.Y.14, you’ll be required to pay tax on the interest income.

Now you know whether interest on income tax refund is taxable and how this interest is taxed.

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