National saving certificate

The reliable National Savings Certificate (NSC) looks like it may have lost popularity with countless competing investment options available such as equities, mutual funds, unit linked insurance and fixed maturity plans. However, there is no ignoring the instrument's respectable returns, which are not only assured, but also tax-exempt (under 80C) and government guaranteed.
 
Compared with the NSC, the Public Provident Fund (PPF) has traditionally been more popular on account of its 8% tax-free interest. However, the PPF has a maximum investment limit of Rs 70,000 per annum (this means the maximum amount one can invest in PPF every year is capped at Rs 70,000).
 
Investment limit
NSCs do not have a limit of how much one can invest. What's more, interest up to Rs 1 lakh is tax-free. You read that correctly. NSCs offer you the possibility of earning up to Rs 1 lakh fully tax-free.
 
This is because NSC is the only small saving scheme wherein not only the initial deposit, but also the interest for the first five years, out of its term of six years, is eligible for a deduction under section 80C.
 
Interest and returns
NSC offers 8% interest compounded half-yearly. Due the compounding, the effective rate per annum works out to 8.16%. It is a cumulative scheme with a term of six years, meaning, though the interest accrues every year, it is paid to the investor together with the initial capital invested at the end of six years. For example, Rs 10,000 invested in NSC today will grow to Rs 16,010 at the end of six years.
 
Tax treatment
Let’s talk about the tax treatment of the interest paid out . Unlike PPF, where the full amount of interest is tax-free, NSC interest is taxable. However, as it is a cumulative scheme (eg interest is not paid to the investor but instead accumulates in the account), each year's interest for the first 5 years is considered reinvested in the NSC. Since it is deemed reinvested, it qualifies for a fresh deduction under Sec 80C, 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.
 
Illustration
Example: You invest Rs 1,00,000 in an NSC on April 1, 2010. Interest on this investment for each year is shown in the following table:
  
April 1, 2010 Initial investment 100,000
Mar 31, 2011 interest for Yr 1:  8,160
Mar 31, 2012 interest for Yr 2:  8,830
Mar 31, 2013 interest for Yr 3:  9,550
Mar 31, 2014 interest for Yr 4:  10,330
Mar 31, 2015 interest for Yr 5:  11,170
Mar 31, 2016 interest for Yr 6:  12,070
Total interest 60,110
Total value of investment:  1,60,110
  
What you must ensure while filing tax return
To benefit from this feature of reinvested interest and its deduction, it is important to declare the accrued interest on NSC on a yearly basis in your tax return. In the above example, for FY 10-11, you will include the interest amount of Rs 8,160 in your tax return under the head “Income from Other Sources”. Under deductions, you will claim Rs 8,160 under Sec 80C as reinvested NSC interest. Both cancel each other out, making the interest in effect tax-free.
  
Important detail:

    

Where and how to buy?
National Savings Certificates (NSC) are certificates issued by Department of post, Government of India and are available at most post offices in the country in denominations of Rs 100, Rs 500, Rs 1,000, Rs 5,000 and Rs 10,000. NSCs can also be transferred from one person to another by paying a small fee. They can also be transferred from one post office to another