By Chirag Nangia

What is the difference between interest earned, interest paid and interest accrued. Which of these should be taken for computation of income (from fixed deposits) for tax purposes?
—T V Mahadevan
Earned interest is the rate of interest that an investment earns on the principal amount. Accrued interest is interest that an investment is currently earning, but that you have not collected yet. In nutshell, you accrue interest all quarter/ month and you receive it on the payment date. Interest paid is interest that you have received as payment into your account. The Income-tax Act has provided two methods viz. accrual method and cash method for accounting of interest received on FDRs. In the case of an accrual method of accounting, incomes are recorded in the books of accounts on an outstanding basis even if the taxpayer has not actually realised the interest in his account. In the case of the cash method of accounting, incomes are recorded in the books on a receipt basis. That is, the taxpayer will record the income only if he actually receives such income in cash. Taxpayers can opt for any of these methods but once a method is chosen, it should be used consistently.

I have invested in NSC VIIth issue. If I include the interest accrued for 1st, 2nd, 3rd and 4th year and show the same as deduction under Section 80C, will the maturity amount after fifth year be exempt from tax?
—Lourdes Aaron
Deposits up to Rs 1.5 lakh in NSC qualify for deduction under Section 80C. Accrued interest on NSC also qualifies for deduction under Section 80C. NSC interest is taxable. However, as it is a cumulative scheme (e.g. interest is not paid to the investor but instead accumulates in the account), each year’s interest is considered reinvested in the NSC. Since it is deemed reinvested, it qualifies for a fresh deduction, thereby making it tax-free. Only the final year’s interest, when the NSC matures, does not receive 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.