Quick personal loans are a ballooning trend these days, and thanks to instant personal loan platforms, this trend is gaining momentum everyday. Since personal loans are unsecured and can be availed easily, a larger number of borrowers find themselves going for these loans to procure funds for their personal needs. These requirements can be anything, such as a wedding, vacation, various education expenses, or other personal projects.
Although personal loans are a quick way to arrange funds, fluctuating interest rates are always a subject of concern for borrowers. This makes tax deductions on personal loans a much needed benefit by borrowers. But the most important question here is, do we actually get tax deductions on personal loans?
Does India’s Income-tax Act (ITA) Allow Tax Deductions on Personal Loans?
When we talk about tax deductions on loans, there are two aspects of any loan, and each aspect is tackled differently by India’s income-tax act in terms of tax benefits. These two aspects are:
- The principal amount of the loan
- The interest charged on the loan
If one is to answer the question about the possibilities of similar tax deductions on personal loans as we get on other types of loans, the plain and simple answer would be “No.”
The Income-tax Act of India does have rules and guidelines for tax deductions and tax exemptions on both the principal and interest of certain loans, such as home loans, education loans, business loans etc. However, the income-tax act does not specifically entertain any tax deductions on your income-tax returns when it comes to personal loans.
Due to the lack of direct mention of tax relaxations on personal loans interest rate and principal in the income-tax act, the end-use of loan money will decide whether tax should be levied on a personal loan or not.
Another key factor here is the source of your loan be it a traditional source or an instant personal loan app. The principal of a personal loan can become taxable or non-taxable depending on the source from which you acquire the loan.
If you take a personal loan from a bank, NBFCs, other legally approved financial institution or applied for personal loans online using an instant loan app, your loan’s principal amount is considered a liability and is not taxable. However, if the amount is borrowed from a friend, relative or other non-professional lending sources, it is viewed as your income and is added to your gross income at the time of income-tax calculations.
But what about the interest paid on personal loans. Can borrower enjoy tax deductions on the personal loan interest? As discussed above, there are certain conditions and the final use of the loan money that will be considered for any tax relaxation.
Here are three circumstances under which a person can avail tax benefits on personal loan:
1. Personal Loan Used for Business
If a borrower ends up investing the personal cash loan in his business, the interest on that loan becomes a liability for that business. Here, the interest paid is considered as an expense and can be deducted from the net profit of the business. This brings down the total amount of taxable net profit. Furthermore, the income-tax act has set any limit on the amount that tax-deductible liabilities of a business. This means that entire interest on the person can be tax deductible if used in business.
2. Personal Loan Used for Buying or Construction of a Residential Property
Section 24 of the Income Tax Act, titled “Deductions from Income from House Property” makes it possible to enjoy tax benefits. According to Section 24, interest paid for funds acquired through a personal loan can be deducted from the net taxable income from residential property, if the money is used for purchasing, constructing or renovating the same property.
Since section 24 of ITA does not specify the type of loan, personal loans are also eligible for said tax deductions. However, the borrower would need to present the required documents to prove the use of personal loan money for buying, repairing or constructing of house. Up to ₹2,00,000 can be claimed as tax deductions on the interest of personal loan if the borrower occupies the house.
3. For Purchasing Assets
If the borrowed funds are used for acquiring jewellery, shares, or any other non-residential assets, the borrower cannot claim any immediate tax relaxation at the time purchasing said assets. However, the interest paid on loaned money used for buying the asset is added to the total cost of acquiring that asset. Therefore if the borrower ever sells the particular asset, the paid interest as part of the acquisition cost is also deducted from the capital gains, effectively reducing the taxable profit.
Instant personal apps like EarlySalary have provided easy access to fast personal loans. Although The income-tax act of India does not explicitly provide any guidelines on tax deductions on personal loans, the vagueness allows other ways to ascertain tax deductions on personal loans. However, tax benefits on personal loans can only be availed if borrowers fulfil certain eligibility criteria by presenting the necessary documents. So it is very crucial to keep safe all documents, bills and certificates relevant to the loan or the use of loaned funds.