As Finance Minister Nirmala Sitharaman prepares to present the Union Budget 2026-27 on Sunday, 1 February 2026, deliberations around rationalising the taxation of household savings instruments have gathered momentum. In its pre-Budget note titled “SBI Research Report: Prelude to Budget 2026-27”, SBI Research has outlined key tax-policy recommendations aimed at improving the post-tax efficiency of bank fixed deposits (FDs).
The proposals focus on two structural aspects:
- Revising the tax treatment of interest earned on fixed deposits, and
- Reducing the lock-in period for tax-saving FDs eligible under Section 80C.
Both measures seek to address declining real returns and restore competitiveness to traditional deposit instruments.
‘Capital Gains Like’ Tax Treatment for FD Interest
Present Tax Regime for Fixed Deposit Interest
Under the existing provisions of the Income-tax Act, 1961, interest earned on bank fixed deposits is classified as “Income from Other Sources”. Such income is aggregated with the taxpayer’s total income and taxed at applicable slab rates, which can reach 30% (excluding surcharge and cess) for individuals in the highest income brackets.
Although the new tax regime provides relief for individuals earning up to ₹12 lakh, depositors with higher taxable income continue to face a significant tax burden on FD interest.
SBI Research Proposal
SBI Research has recommended that interest income from fixed deposits be taxed in a manner analogous to capital gains, rather than at marginal slab rates. Specifically, the proposal envisages:
- Short-term capital gains–like taxation for shorter-tenure deposits, and
- Long-term capital gains–like taxation for deposits held beyond a defined holding period.
Such a framework would replace progressive slab-based taxation with concessional, rate-based taxation.
Economic Rationale
The proposal assumes significance in the context of a softening interest rate cycle, with banks progressively reducing FD rates. For high-income investors, the combination of lower nominal returns and slab-rate taxation materially diminishes post-tax yields. In contrast, capital gains taxation typically:
- Applies lower, predetermined rates,
- Offers threshold exemptions or indexation benefits in certain cases, and
- Ensures greater predictability in tax outcomes.
Extending similar treatment to FD interest could substantially reduce tax outgo for depositors, particularly retirees and risk-averse investors who rely on fixed-income products.
Legal and Structural Considerations
From a tax-law standpoint, capital gains ordinarily arise from the transfer of a capital asset, such as equities, mutual funds, immovable property, or gold. Fixed deposits, by contrast, generate interest income pursuant to a contractual obligation, without any transfer of a capital asset. Accordingly, implementing this proposal would require:
- Legislative intervention, either through reclassification or a special charging provision, and
- Clear statutory definitions for holding periods and applicable tax rates.
That said, differentiated tax treatment across income streams is not uncommon where supported by policy rationale and fiscal objectives.
Proposal to Reduce Lock-In Period for Tax-Saver FD
Current Section 80C Framework
At present, only five-year tax-saving fixed deposits qualify for deduction under Section 80C, subject to the overall limit of ₹1.50 lakh. These deposits are characterised by:
- A mandatory five-year lock-in, and
- No premature withdrawal facility.
Fixed deposits with shorter tenures, irrespective of interest rates, do not qualify for the deduction.
SBI Research Recommendation (match with ELSS)
SBI Research has proposed reducing the lock-in period for tax-saver FDs from five years to three years, thereby aligning them with Equity Linked Savings Schemes (ELSS). ELSS mutual funds currently:
- Offer the same Section 80C deduction,
- Have a three-year lock-in, and
- Are often preferred due to relatively higher flexibility.
Policy Implications
Reducing the lock-in period would:
- Create parity between debt-based and equity-based tax-saving instruments,
- Enhance liquidity and choice for conservative investors, and
- Improve the relative attractiveness of tax-saving FDs, which have steadily lost share to ELSS funds.
From a banking perspective, such rationalisation could also support stable deposit mobilisation without imposing disproportionately restrictive conditions on depositors.
Conclusion
The recommendations put forth by SBI Research reflect a broader policy push towards tax neutrality and investor equity across savings instruments. By advocating ‘capital gains like’ taxation for fixed deposit interest and a shorter lock-in for tax-saver FDs, the report seeks to modernise the tax treatment of traditional savings in line with evolving market realities.
Whether these proposals find place in the Union Budget 2026-27 remains to be seen. If implemented, however, they could mark a structural shift in the taxation of fixed-income investments, offering tangible relief to depositors while rebalancing India’s savings landscape.
Source: News18