Are Personal Loans Tax Deductible In India?

Are Personal Loans Tax Deductible In India?

May 3, 2023

Quick personal loans are common these days. With instant personal loan platforms available today, this trend is gaining momentum every day. Personal loans are unsecured and can be availed of easily. This is why a larger number of borrowers find themselves going for these loans to procure funds for their personal needs. These requirements may include wedding, vacation, education expenses or other personal projects.

Personal loans are a quick way to arrange funds. However, it is important to find a lender with affordable interest rates. In this context, tax deductions on personal loans are a much-needed benefit for borrowers. But the most important question here is, are personal loans taxable?

Does India’s Income-tax Act (ITA) Allow Tax Deductions on Personal Loans?

When we talk about the personal loan tax deduction, there are two aspects of any loan. 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 a tax rebate on personal loan the simple answer would be “No.”

The Income-tax Act of India has rules for tax deductions and exemptions on both the principal and interest of certain loans. These include home loans, education loans, business loans etc. But the act does not entertain any tax deductions on income tax returns in the case of personal loans.

The end-use of loan money will decide whether tax should be levied on a personal loan or not. This is due to the lack of direct mention of tax relaxations on personal loans interest rate and principal in the income-tax act.

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.

Suppose you are taking a personal loan from a bank, NBFCs or other legally approved financial institution. In that case, your loan’s principal amount is considered a liability and is not taxable.

Additional read: NBFCs vs Banks: Here’s what you must know!

The rule is the same if you apply for personal loans online using an instant loan app. However, if the amount is borrowed from a friend, relative or other non-professional lending sources, it is viewed as your income. Such income is added to your gross income at the time of income-tax calculations.

But what about the interest paid on personal loans? Can a 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 of tax benefits on a 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 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 number of tax-deductible liabilities of a business. This means that the 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. Section 24 will apply 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. The borrower would need to present the required documents to prove the use of personal loan money. Up to ₹2 lacs can be claimed as tax deductions on the interest of a personal loan if the borrower occupies the house

3. For Purchasing Assets

Suppose the borrowed funds are used for acquiring jewellery, shares or any other non-residential assets. In that case, the borrower cannot claim any immediate tax relaxation at the time of 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 a particular asset, the paid interest is also deducted from the capital gains. It is cut as part of the acquisition cost. This will effectively reduce the taxable profit.

Wrapping Up

Instant personal apps like Olyv (formerly SmartCoin) have provided easy access to fast personal loans. The income-tax act of India does not explicitly provide any guidelines on taxes on personal loans. This vagueness allows other ways to ascertain tax benefits. Tax benefits on personal loans can only be availed if borrowers fulfill certain eligibility criteria. This can be proved 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.