Income Tax on Loan from Friends or Relatives in India
Nimisha Panda- 2 days ago
- 7 min read
Sometimes, instead of going to a bank or a third-party lender, one could think about getting a loan from a friend, relative, or other close friend. Although there is nothing unlawful about it, the loan's monetary limit must be taken into account. In order to prevent future disagreements between the parties and in case the income tax authority requests one, people should think about putting a loan agreement in writing for future reference. The tax ramifications of loans between friends and family will be covered in this article. We'll look at how the interest paid affects your tax return and whether you, the borrower, are taxed on the loan amount.
Table of Contents
Income Tax Restrictions on Taking and Giving Personal Loans
One of the major issues promoting economic inequality in India is tax avoidance. Tax evasion rises as a result of unaccounted money created by fraudulent cash transactions. The government has put in place a number of rules and regulations as well as restrictions on personal loans borrowed from friends and relatives to avoid such incidents of tax evasion. These are:
A loan exceeding Rs 20,000 cannot be accepted in cash or by bearer check; instead, the transaction must be made through a bank account using a payee check, electronic transfer, bank draft, or another method; this rule is even applicable if the entire amount is borrowed in installments or in different par. For example, A cannot borrow a further Rs 15,000 in cash if he has already borrowed Rs 10,000 (perhaps by check or electronic transfer) and wants to do so because the total amount would be more than Rs 20,000. If this regulation is broken, the loan recipient will be responsible for paying a penalty equivalent to the amount that was received in violation, which would be Rs. 25000 if A accepts this 15000.
Repayment of the same loan is the second constraint. Additionally, up to Rs 20,000 in cash or bearer checks may be used to cover all or part of the repayment. The borrower will be subject to the penalty if this rule is broken.
Loans between Indian residents and non-resident Indians (NRIs) are prohibited. Only non-resident Indians (NRIs) or individuals of Indian descent may lend money to an Indian in Rupees.
The duration of loans from family or friends is limited to no more than three years.
The interest rate is limited to 2% above the market bank rate.
Only friends and family who are non-resident Indians (NRIs) may receive loans from an Indian resident. This loan must be interest-free and available for a maximum of one year. Additionally, there are restrictions and limitations on the loan amount.
An Indian resident can only borrow foreign currency from close relatives who do not dwell in the country; they cannot borrow from other non-residents.
Such a loan cannot exceed $250,000. In addition to being interest-free, the loan should be taken out for a minimum of one year.
According to the proviso to Section 269SS, if both the borrower (the person receiving the loan) and the lender (the person from whom the loan is taken) receive agricultural income, the terms of this section will not apply to any loan, deposit, or specified sum. Furthermore, according to the Income Tax Act, neither party should have any income that is taxable.
Receiving Money from Family or Friends Through UPI/e-Wallets
With going cashless, it is now incredibly easy to send money to other individuals over the phone. UPI/E-wallets can be used to pay off friends' debts.
You are exempt from paying taxes on these transfers if they constitute receipts of obligations owed to you. In this situation, you must provide a written letter confirming that the transaction is a debt settlement if the income tax department conducts an examination.
This kind of settlement might be seen as a gift and is therefore exempt from taxes if it is a straightforward receipt.
Notably, the amount should not exceed Rs. 50,000, and bigger e-wallet transfers will be taxable.
Tax Implications of Loans to or From NRIs
The Foreign Exchange Management Act (FEMA) regulates borrowing and lending activities between residents and non-residents in India. It states that a resident individual may borrow money in foreign currency or Indian currency from an NRI if certain conditions are fulfilled, and that an NRI may lend money to a resident individual in foreign currency or rupees as long as certain requirements are met. These requirements include:
Banking channels must be used for the loan transactions.
With the exception of stock market or real estate investments, loans should only be used for business or personal objectives.
The duration of the loan should be at least one year and no more than three years.
The loan's interest rate shouldn't be higher than either the Reserve Bank of India's (RBI) established rate or the going market rate.
Reporting of the loan to the RBI is needed within 30 days of receiving or disbursing the amount.
The residential status of both the borrower and the lender determines how interest paid or received on the loan is taxed. The type of loan, the nature of the income, and the Double Taxation Avoidance Agreement (DTAA) between India and the NRI's home country are some of the variables that affect the tax implications. Important points consist of:
As other income in the NRI's possession, interest paid by a resident to an NRI on a foreign currency loan is subject to a 20% withholding tax rate (plus surcharge and cess) or the rate outlined in the DTAA, whichever is lower.
Interest paid by a resident to an NRI on a loan denominated in rupees is subject to 30% withholding tax (plus surcharge and cess) or the rate set forth in the DTAA, whichever is lower, and is taxable as other income in the NRI's hands.
Interest received by a resident from an NRI on a loan in rupees or foreign currency is subject to standard tax rates and is taxable as other income in the resident's possession.
Sections 24 for housing loan interest, Section 10(15) for interest on specific bonds or deposits, Section 80E for education loan interest, and others may allow for the deduction or exemption of interest paid or received on the loan.
Services like income tax e-filing offer a practical way for people to file returns if they want to effectively manage their tax responsibilities. It's critical to keep track of the ITR filing deadline and make use of tools like online refund status to monitor refunds. Additionally, taxpayers can more easily manage their responsibilities if they are aware of income tax slab rates and income tax notice procedures.
Tax Liability for Interest Income for a Loan Given to Family or Friends
The following criteria must be fulfilled for interest earned on loans to relatives or friends:
Tax-exempt: The loan must be documented with a written agreement outlining the terms and conditions, including interest rate and repayment schedule; the interest rate charged must be at least equal to the going bank rate for similar loans; the loan cannot be made in cash for more than Rs. 20,000 (unless through banking channels).
The specified relatives must be the spouse, siblings, parents, children, grandchildren, grandparents, great-grandchildren, spouse's parents and siblings, and their spouses.
Taxable: The interest income will be subject to taxation under the "Income from Other Sources" heading at the relevant tax rate determined by your income slab if any of the aforementioned conditions are not fulfilled.
Deductions for a Loan Given to Family or Friends
Section 24 permits a deduction for the interest paid on a house loan obtained from friends or family members. The deduction is only eligible to be taken after the house is finished or the owner takes ownership of it. The Income Tax Act does not make it clear that only loans from particular institutions will qualify for deductions. If the property is self-occupied, the deduction maximum for interest paid is Rs.2 lakh annually; if the property is rented out, the deduction limit is unlimited. You can only deduct interest if the dwelling property's construction is finished and paid for in five equal installments. However, repayment of the principal on a home loan taken from family members or friend cannot be claimed as a deduction.
For example, X spends Rs 10 lakh for a residence. He obtained this loan from Y, a relative, in order to buy this property. The loan has an annual interest rate of Rs 5% and can be repaid in ten equal payments. He paid back Rs 1 lakh in principal and Rs 50,000 in interest for the fiscal year 2021–2022. For the repayment of Rs 50,000 in interest, X is qualified for a deduction under Section 24. However, as Section 80C does not allow for the repayment of loans from friends or family, he is unable to claim a deduction for the principal payback.
Conclusion
If you receive interest on a loan that you made to a friend or a family member, you must understand its tax implications. Under the heading "Income from Other Sources," interest received from such a loan is subject to taxation. As a result, you must include this in your ITR. At the same time, borrowers also have to follow certain tax regulations in these situations. It is best to seek expert advice whether you are a borrower or a lender.
Frequently Asked Questions
Are loans from friends or relatives taxable?
No, a loan from a friend or family member is exempt from taxes. However, these loans shouldn't be made in cash.
Can I give an interest-free loan to a friend?
Yes, anyone can lend money to friends or family at a discounted rate or without interest, but such loans shouldn't be given or collected in cash. Any of the following methods—payee check, electronic transfer, bank draft, etc.—must go via a bank account.
Who has to bear the taxation responsibility on the interest earned from loans to friends or relatives?
The lender of the loan is responsible for paying taxes on the interest gained if they charge friends or family interest.
Does a loan from a family member require you to pay taxes?
You can give friends or family a loan with a low interest rate, but whatever interest the lender charges on the loan is taxable, and the lender is required to pay taxes on the funds received.
If I borrow money from a friend, is it taxable in India?
No, it is not taxable to borrow money in this case if your friend is in India. Income does not include the loan amount itself. But if you pay interest on the loan, the friend who gave you the money will have to pay taxes on the interest income.
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