What is Interest on Income Tax Refund?

The due date for filing income tax returns (ITRs) for individuals is July 31 of the relevant assessment year. With the ITR filing due date for FY 2023-24 (or AY 2024-25), which was July 31, 2024, now behind us, many taxpayers are awaiting their income tax refunds. If you too have a refund to look forward to this year, there’s some good news for you. You may also be eligible for interest on the income tax refund.

Not sure what interest on the income tax refund is and how it works? In this article, we take a deep dive into this interest income — including what it is, how it is calculated and when it is paid. To better understand interest on the income tax refund, let us start with a discussion on the refund itself. 

Income Tax Refund: An Overview

An income tax refund is offered when the tax you paid exceeds the tax you owe the government. Often, you may not be aware of the exact amount of tax liability till the end of the financial year. However, you will have to pay advance tax during the financial year, so you may have paid more tax than you owe. 

Similarly, income tax may have been deducted as TDS from various income receipts. Together, this may lead to excess tax payments. In such cases, you may be eligible for an income tax refund (as well as interest on the income tax refund). 

However, merely paying excess taxes is no guarantee of receiving a refund. The Income Tax Department should process your ITR and issue an intimation u/s 143(1) of the Income Tax Act confirming the numbers. Only then, you will be eligible for an income tax refund. 

If the Income Tax Department also finds that you have paid more taxes than is due, a tax refund will be initiated after your ITR has been processed. In India, the State Bank of India (SBI) has been tasked with the responsibility of processing IT refunds. Once your refund is processed, it is deposited directly into the bank account mentioned in your ITR. 

An Example of Income Tax Refund

Let us discuss a hypothetical example of how IT refunds work. Say you earn an annual salary of Rs. 10,00,000. Your employer deducts TDS of Rs. 1,00,000 based on your estimated tax liability. However, when you file your ITR, you realise that you are eligible for various deductions that reduce your tax liability to Rs. 80,000. 

In this scenario: 

• Total tax paid via TDS: Rs. 1,00,000
• Actual tax liability: Rs. 80,000
• Excess tax paid: Rs. 20,000

After processing your income tax return, if the Income Tax Department confirms that you overpaid by Rs. 20,000, this amount becomes your income tax refund. It will be credited to the bank account you mentioned in your ITR. This example illustrates how tax deductions can lead to overpayment and subsequent refunds when filing returns.

Interest on Income Tax Refund

In finance and money matters, the concept of interest is simple. It is a charge levied on any amount that is paid belatedly. In the case of income tax refunds, there is always a slight delay between the date of filing your income tax return and the date of receiving your refund. To compensate taxpayers for this waiting period, the Income Tax Department offers interest on the income tax refund. 

Once you file your income tax return, you will receive the notification u/s 143(1), which may contain any of the following outcomes:

• Scenario 1: Your income tax calculation aligns with the IT department’s computation of income and you do not need to pay any additional tax. 
• Scenario 2: Your tax calculation does not align with the IT department’s computation and you either have to pay additional tax, or your claim for an income tax refund is partially accepted or entirely rejected. 
• Scenario 3: Your income tax calculation aligns with the IT department’s computation of income and you are eligible for the entire refund requested.  

In the first scenario, you will not receive a refund. However, in the second, you may. And in the third, you will receive the refund request. The interest on the income tax refund, if any, will also be credited along with the refunded amount.  

Important Things to Know About Interest on the Income Tax Refund 

As a taxpayer, there are a few crucial things you must be aware of about the interest on the income tax refund. Check out these details below:

• Income Tax Refund Interest Rate

The income tax refund interest rate is 6% per annum or 0.5% per month or part of the month. So, for example, say you are eligible for a tax refund of Rs. 10,000 and the interest is due for 10 months. In this case, the interest on the income tax refund will amount to Rs. 500 (i.e. Rs. 10,000 x 0.5% x 10).

• Period for Interest Calculation

The period over which the interest on the income tax refund is calculated depends on when you file your income tax returns. Typically, if you have submitted your ITR on or before the due date as specified u/s 139(1), interest on the income tax refund will be calculated from April 1 of the assessment year till the date of refund receipt. However, if you have filed your tax return after the due date u/s 139(1), the interest on your income tax refund will be calculated from the date of ITR submission till the date of refund receipt. 

• Ineligibility for Interest on Income Tax Refund

Not everybody who receives a refund will be eligible for interest on that income tax refund. If the amount of refund due does not exceed 10% of your total tax liability, you will not receive any interest on the refund. 

For instance, say you have a tax liability of Rs. 1,00,000 and are eligible for a refund of Rs. 5,000. Since the refund amount does not exceed 10% of the tax due (i.e. 10% of Rs. 1,00,000, which is Rs. 10,000), you will be ineligible for any interest on the income tax refund amount.   

• Taxability of Interest on Income Tax Refund

The amount received as an income tax refund is not classified as income. So, it is not subject to any tax. However, the interest on the income tax refund is considered income as per the Income Tax Act, 1961. So, it is subject to tax as ‘Income from Other Sources.’

Conclusion

So, you now know what the meaning of interest on the income tax refund is and how it works. You can also figure out, even at the time of filing your ITR, whether you will be eligible for interest on the income tax refund. This will help you plan for the additional cash flow in advance. You must also remember to include this interest on the income tax refund in your tax returns for the next financial year.