Synopsis: Interest earned on Income Tax refund is considered an income and is taxable under the head, ‘Income from Other Sources’. The interest has to be added in the Income Tax Return in the Financial Year in which the refund was received.
The tax environment in India has experienced its biggest overhaul in more than sixty years. Income Tax Act 2025 took effect from April 1, 2026, replacing the previous legislation known as Income Tax Act 1961 in respect of income received since Tax Year 2026-27. The essence of the taxation laws is not altered, but sections have been renumbered, language revised to reflect current terms, and clarity added. This article explores everything that one needs to know about the taxation of interest from income tax refunds. Before diving in, it is necessary to determine the act applicable to you:
- Income until 31st March 2026 (Financial Year 2025-26) shall remain subject to the provisions of the Income Tax Act, 1961. If your ITR is being filed for the Financial Year 2025-26, the old act will apply to you.
- Income after 1st April 2026 (Tax Year 2026-27) will be covered under the new Income Tax Act, 2025.
It must be noted that both acts will operate simultaneously for a certain period, as proceedings of the past years will remain under the old act.
Difference between Refund and Interest
In cases where you have paid an excessive amount of tax, whether due to TDS (Tax Deducted at Source), Advance Tax, or Self-Assessment Tax, the government gives you back the surplus amount as an income tax refund. The income tax refund received by taxpayers from the Income Tax Department is not subject to any taxation, it is only your money refunded to you and has already been considered in your ITR.
However, when the refund takes a certain time to be processed and credited to the taxpayer, the Income Tax Department pays interest on the refunded amount. In such cases, the interest amount becomes part of your income and is fully taxable under the new Act.
What has Changed Under the New Income Tax Act
One of the significant structural changes is reflected in the language used in The Income Tax Act, 2025:
- While previously “Previous Year” and “Assessment Year” were distinct terms, now both concepts have merged into one term – “Tax Year”, which means a period of twelve months beginning on 1st April.
- Instead of saying “from 1st April of the Assessment Year,” as was used in the previous Act, now it will be mentioned “from 1st April of the Tax Year.”
- All the rules related to filing of returns (including original return, belated return, revised return, and updated return) are stated in Section 263 of the new Act, compared to Section 139 in the 1961 Act.
These are changes in language and structure, not in the substance of the law.
Also read: 7 Major Tax Deductions to Reduce Capital Gains Tax for Individual Taxpayers in India
Refund Provisions Under the New Act
In accordance with the Income Tax Act, 2025, the entire section relating to refunds has been amended, and it now falls under Sections 431 to 438 in place of Sections 237 to 245 of the previous Act of 1961. The most important sections are as follows:
- Section 431 – When a refund is required: whenever the total tax payment exceeds the amount of the actual liability in the Tax Year.
- Section 433 – Every refund shall be claimed by submitting the income tax return.
- Section 437 – The interest for delayed refunds covers the amount, the period, and the criteria under which it becomes applicable.
Rate of Interest on the Refund
Under the new act, Section 437(1), where there exists a tax refund due to a taxpayer, then such a person will be able to access the simple interest at the rate of 0.5 percent per month on the tax refund in addition to the tax refund itself. Such an interest amounts to 6 percent per annum. It is important to note that the interest is simple and not compounded. For the calculation of interest, the commencement date shall be as follows:
- Filing of the tax return on or before the due date in Section 263(1): Commence from 1st April of the subsequent year from the Tax Year until the date when the tax refund is approved.
- Filing of the tax return beyond the due date: Commences from the date when the tax return was filed to the date when the tax refund is approved.
Under Section 437(2), interest is not payable if:
- The refund amount does not exceed 10% of the total tax liability in the Tax Year.
- The delay in processing the refund is due to the conduct of the taxpayer, such as erroneous entries in the return, lack of documentation, incorrect banking information, or non-compliance with notices issued by the department.
Under Section 437(3), in addition to the regular rate, there will be an extra 0.5% interest charged monthly in respect of a refund resulting from an order made by the Assessing Officer consequent on a particular application made by the assessee.
How Is the Interest on Refund Taxed?
Interest on an income tax refund earned after the implementation of the New Act will be treated as taxable as per Section 92, which is the new counterpart to Section 56 of the old Income Tax Act, 1961. As per Section 92 of the Income Tax Act, 2025, “income from other sources” will include those incomes that do not come within the scope of salary, house property, business & profession, or capital gains.
This interest should be included in the relevant ITR about the year when such interest is earned and not the year to which the income tax refund belongs. This income is subject to taxation based on the slab rate applicable to you. Furthermore, this is also settled by case laws. The Supreme Court held that interest on an income tax refund will be completely taxable with no possibility of exemption.
TDS on Interest
As per the Income Tax Act, 2025, the TDS provisions of Section 192 to 194T of the old Act, 1961, have been covered under Sections 392 and 393 of the new Act, 2025. The Income Tax Department can deduct TDS on your interest portion while making the refund payment. Your TDS credit, if any, will show up in your Form 26AS and Annual Information Statement (AIS). It is always wise to verify your AIS statement prior to filing your return. If there is any TDS on the interest amount, then you can set it off against your tax payable while filing your ITR.
Where to Report It in Your ITR
Interest earned from a tax refund should be reported under the category “Income from Other Sources.” This will apply to all ITR forms, such as ITR-1 and ITR-2, according to the taxpayer’s income status. Remember that interest income should always be reported in the Tax Year during which the interest is received.
Written by Shrikara
