What are the restrictions under income tax act on giving and taking personal loans?

To regulate personal loans from friends and relatives government has made certain rules and regulations and also implemented various restrictions. They are as follows:

  • The first restriction is one cannot accept a loan exceeding a limit of Rs 20000 in cash or by bearer cheque. The transaction must be through bank account in various ways such as payee cheque, electronic transfer, bank draft and so on. This rule is even applied if the total amount borrowed in various parts or installments. The limit of total transfer through cash is Rs 20000. For example : If Mr X have taken a loan of Rs 10,000 earlier (maybe even by cheque or electronic transfer) and now intend to borrow another Rs 15,000 in cash, he cannot do so, as the balance would exceed Rs 20,000.
    In case of violation of this rule, the receiver of the loan will be liable to pay a penalty equal to the amount accepted in violation. However, the violation will be decided by the tax officer who will be dealing with your case whether it is reasonable or not for a violation.
  • The second restriction is on the repayment of the same loan. The repayment should also be paid wholly or partially through cash or bearer cheque upto the limit of Rs 20000. If this rule will be violated the penalty would be applied to the borrower.
  • The third restriction is loans between Indian residents and Non-resident Indians(NRIs). An indian can only accept loan from a Non-resident Indians(NRIs) or a person of Indian origin and not from other Non-residents.
    The period of this type of loan is also restricted to not more than three years.
    The interest rate is also restricted to 2% over the bank rate
  • The fourth restriction is an Indian resident can only give loans to a Non-resident Indian (NRI) relative. This loan can only be given for a period of one year and has to be interest free. The amount of loan is also restricted and has some limits.
  • The fifth restriction is an Indian resident can only take foreign exchange loan from his close non-resident relatives and not from other non-residents.
    The amount of such loan cannot exceed $250,000. The loan should be taken for at least one year and that too interest free.

Receiving money from friend through e-wallet

With becoming cashless it is now very easy to transfer money to other people through phone. This is done through UPI, e wallets and so on. Even the debts of friends can be cleared through e wallets.

  • If in case these transfers are receipts of debts owed to you, you don't have to pay tax on it. In his case scrutiny is done by the income tax department and you have to submit a written note stating the transaction is settlement of debts.
  • If this type of settlement is simple receipt it may be treated as gifts and thus are not taxable.

For example: If you go out with six friends on a trip and you spend on the complete expenditure with the total amount of Rs 35,000. Afterwards your friends pay their share through an app or UPI giving you back a total amount of Rs 30000 . These transactions will be taken as gifts and will not be taxed. As this transaction will be settlement of the debts owed to you and it is tax free.


Point to be noted

The amount should not exceed the sum of 50,000. Any bigger amount transferred by friends through e wallets will be taxable.


Deductions for the loan taken or given

Interest repayment for a home loan that is taken from friends or relatives can be claimed as a deduction under section 24. The deduction can only be claimed when the construction of the house is complete or the possession is received by the individual.The income tax act does not specify clearly that deduction will be available only for loans from specified banks.

On the other hand repayment of the principal on a home loan borrowed from friends or relatives can’t be claimed as a deduction under this section.

For Example: “Mr. A purchases a house for Rs 10 lakh. He took this loan from his relative Mr. V for the purchase of this property. The loan is repayable in 10 equal installments with an interest of Rs 5% per annum. He repaid the principal of Rs 1 lakh and an interest of Rs 50000 for the financial year 2016-17.”
“Mr. A is eligible for a deduction under Section 24 for interest repayment of Rs 50000. But he can’t claim a deduction under Section 80C for the principal repayment as the deduction is not available for the repayment of the loan from friends or relatives.”


Conclusion

From the above discussion, it can be seen that even for simple things such as personal loans that are received or given to friends or relatives, there are various restrictions and regulations that everyone should be aware of.


Frequently Asked Questions

Q- Is taking loan from friends or relatives taxable?

No, loan from friends or relatives are tax free. No borrower is taxable for any sort of loan.


Q- Who is responsible for taxation on the interest earned from giving loans to friends or relatives?

The lender of the loan if charges interest from friends or relatives is liable to pay tax on the interest earned.


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CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2Win.in. Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.