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We find many payroll managers being unaware that loans provided to employees (by the employer) are taxable in the hands of the employees. The typical reactions (from payroll managers) we come across when we talk about taxability of loans provided to employees are as follows.
"1. A loan is something that an employee repays. Where is the question of salary here? If loan is not salary, how can it be taxed?
2. We give loan under the head ‘Salary Advance’ and hence we think it is not taxable."
Loans provided to employees are taxable as per Rule 3(7)(i) of the Income Tax Rules. However, the actual tax amount on loan provided will depend on the interest rate the employee pays. According to the income tax rules, if loans are provided at a rate which is less than the interest rate charged by the State Bank of India (SBI), then the employee who receives the loan is deemed to have received the loan at a concessional interest rate. The extent of “concession” is a benefit which is taxable.
For example, if an employee receives a personal loan at the rate of 0% (interest-free loan) from the company in which he is employed, and if the interest rate charged by SBI for personal loan is, say, 15% per annum, then the interest cost “saved” by the employee (to the extent of 15% in this case) is deemed to be a perquisite which is taxable in the hands of the employee. The payroll manager should calculate the interest saving (difference between 15% and 0%) in Rupee terms and add the total interest saving for the year to the taxable salary of the employee for the purpose of taxation.
Of course, in the above example, if the company provides the personal loan at the rate of 15% or more (equal to or greater than the interest rate charged by SBI) to its employees, then as per Rule 3(7)(i) the loan cannot be deemed to be a concessional loan and consequently the perquisite value of such a loan shall be zero.
Payroll managers will do well to make note of the following:
1. If any payment made to an employee is in the nature of loan, Rule 3(7)(i) will govern the taxability of the same. Just because the loan is called by some other name by the company, it cannot be left out from the ambit of taxation. After all, rose, called by any other name, would still smell the same.
2. Salary advance and loan are two different things. A salary advance is compensation paid to an employee ahead whenever it falls due – for example, salary for May 13 which is typically paid on 31-May is paid on, say, 15-May. Salary advance is taxable as per the Section 17 of the Income Tax Act. However, loan taxability is governed by Rule 3(7)(i).
Let us take a look at Rule 3(7)(i) in detail and examine the conditions which govern perquisite calculation on loan provided to employees. The text of Rule 3(7)(i) is as follows.
The value of the benefit to the assessee resulting from the provision of interest-free or concessional loan for any purpose made available to the employee or any member of his household during the relevant previous year by the employer or any person on his behalf shall be determined as the sum equal to the interest computed at the rate charged per annum by the State Bank of India, constituted under the State Bank of India Act, 1955, as on the 1st day of the relevant previous year in respect of loans for the same purpose advanced by it on the maximum outstanding monthly balance as reduced by the interest, if any, actually paid by him or any such member of his household:
Provided that no value would be charged if such loans are made available for medical treatment in respect of diseases specified in rule 3A of these Rules or where the amount of loans are petty not exceeding in the aggregate twenty thousand rupees:
Provided further that where the benefit relates to the loans made available for medical treatment referred to above, the exemption so provided shall not apply to so much of the loan as has been reimbursed to the employee under any medical insurance scheme.
From the above, the key conditions are as follows:
1. Loan provided by a company to any member of its employee’s household is deemed to be loan provided to employee for the purpose of taxation. “Household” in this regard includes the employee’s spouse(s), employee’s children and their spouse(s), employee’s parents and employee’s servants and dependents.
2. For loan to be taxable, the total amount of loan given to an employee in a tax year should be more than Rs 20,000. If the loan amount provided to an employee is less than Rs 20,000 in a year, the same shall be non-taxable.
3. Please note that if an employee receives more than one loan (with each loan amount less than Rs 20,000) in a tax year, the aggregate of all loan amounts he receives should be looked at for the purpose of taxation. If the aggregate amount is more than Rs 20,000, the loan amounts shall be taxed.
4. If any loan is provided to an employee for the purpose of meeting his medical expenses towards the treatment of a disease specified in rule 3A of income tax rules, such a loan shall be non-taxable. However, if an employee receives payment under any medical insurance scheme for the treatment of a disease specified in Rule 3A, the loan to that extent shall be taxable.
5. For the purpose of loan perquisite calculation, interest rest rate charged by SBI for a similar loan as on first of April in the year in which the loan is provided to the employee should be considered. For example:
- If the loan is provided for the purpose of buying a car, SBI’s car loan rate should be looked at as the reference rate.
- If the loan is a personal loan, SBI’s personal loan interest rate should be considered as the reference rate.
The interest rate charged by SBI as on 01-Apr should be considered as the reference rate. SBI publishes the interest rate (as on 01-Apr) each year on its website.
The interest benefit to the employee (difference between the SBI interest rate and the interest rate charged by the employee’s organization) should be calculated on the “maximum outstanding balance” of the loan each month. According the income tax rules, “maximum outstanding balance” means the aggregate outstanding balance for each loan as on the last day of each month. For example, if an employee receives a loan of Rs 1 lakh and repays Rs 10,000 each month by way of deduction from his salary, the maximum outstanding balance at the end of the first month of his loan repayment schedule shall be Rs 90,000 (Rs 1,00,000 minus Rs 10,000 repaid at the end of the first month). The interest benefit should be calculated on Rs 90,000 at the end of the first month. Likewise, the interest benefit should be calculated on Rs 80,000 at the end of the second month and so on.
We will look at some illustrations on calculation of perquisite value on loan provided to employees in the next post.
Hinote provides services/software related to payroll.