Jun 172015

Interest free loan from employer and loans at concessional rates

In some cases companies extends loan facility to its employee for various purposes – like education, medical treatment, marriage, etc. These loans are generally free and recovered from salary of employees in the form of deduction of equal amount over a period of time, which vary from 6month to 7 years as per policy of company. Due to such arrangement employees are benefited in terms of interest free loan which they otherwise needs to pay if the same fund arrangement is done from some alternative arrangement and income tax act imposes tax on such notional income by treating such loan arrangement as perquisite. Today we will understand the method of calculating such notional interest income.

Valuation of perquisite in respect of interest-free loan or loan at concessional rate of interest-

If a loan is given by the employer to the employee, it is a perquisite chargeable to tax. It is taxable on the following basis –

Step 1 Find out the “maximum outstanding monthly balance (i.e., what is the aggregate outstanding balance for each loan as the last day of each month)
Step 2 Find out rate of interest charge by the State bank of India (SBI) as on the first day of the relevant previous year in respect of loan for the same purpose advanced by it
Step 3 Calculate interest for each month of the previous year in respect of the outstanding amount mentioned in Step 1 at the rate of interest given in Step 2.
Step 4 From the total interest calculated for the entire previous year under Step 3, deduct interest actually recovered, if any, from the employee during the previous year.
Step 5 The balancing amount [i.e., Step 3 minus Step 4] is taxable value of perquisite.

When Interest on Loan Is Not Chargeable To Tax –

In the following cases, the perquisite is not chargeable to tax –

Case 1 If a loan is made available for medical treatment in respect of diseases specific in rule 3A.The exemption is, however, not applicable to so much of the loan as has been reimbursed to the employee under any medical insurance scheme.
Case 2 Where the amount of original loan (or loans) does not exceed in the aggregate Rs. 20,000/-.

Example 1 –

Mr. X takes a loan of Rs. 2,00,000/- from his employer on May 1, 2015 for medical treatment of Mrs. X (medical treatment is specified in rule 3A). Hospital bill is Rs. 2,00,000/-. The perquisite is not chargeable to tax.

Suppose in this case insurance claim of Rs. 50,000/- is received on October 15, 2015 which is retained by Mr. X. In such a situation, interest on Rs. 50,000 will be chargeable in hands of Mr. X with effect from October 15, 2103.

Example 2-

Mr. X takes loan of Rs. 15,000/- from his employer on May 28, 2014 (assuming no other loan is taken so far). As the amount of loan does not exceed Rs.20,000/-, nothing is chargeable to tax.

Suppose in this case another loan of Rs.5,500/- is taken from the employer on May 17, 2015. Now the aggregate amount of loan exceeds Rs. 20,000/-. Consequently, interest on Rs. 20,500/- (i.e., Rs.15,000/- + Rs.5,500/-) will be chargeable to tax with effect from May 17, 2015.

Example 3-

Mr. X takes a loan of Rs. 1,70,000/- from his employer on October 1, 2003. It is repayable by way of quarterly installments. On April 1, 2015, the outstanding amount is Rs. 20,000/-. The perquisite is not exempt from tax, as the amount of original loan is more than Rs.20,000.

The following points should be noted –

  • Interest will be calculated according to the method given above. No other method (e.g., cost of capital / fund to employer) shall be taken into consideration.
  • If a closely- held company given a loan to an employee who holds at least 10% voting power, such loan is deemed as dividend under section 2(22)(e), if a few conditions are satisfied . Even in such a case, the perquisite value of interest-free loan is chargeable to tax.
  • National interest on interest-free security deposit given by the employer (for a flat belonging to the employee taken on lease), cannot be treated as perquisite.

Hope, the above blog will help you to understand the nature timing and extent of taxing notional interest on loan extended by employer free of cost. In our upcoming blogs we will elaborate more on underling principles with the help of practical examples.