Is an Interest-free Loan from Employer Taxable?

Do you know that you can take a loan on your salary from your employer? The loan from your employer may be interest-free or at a concessional rate. For example, you may be required to only pay the money you have taken from the employer and need not pay any interest for this loan, or pay concessional interest. The interest-free or concession in interest is taxable for an employee. Here’s a look at the tax treatment of interest-free or concessional loans under the income tax law

Is the Interest-free Loan from the Employer a ‘Perquisite’?

A ‘perquisite’ is a benefit offered by the employer to an employee based on his job designation. Such a benefit is considered under the head ‘Salary’ for tax purposes. Similarly, an interest-free or concessional loan provided by an employer is taxable as a ‘perquisite’ for an employee. Therefore, the employer should deduct tax at source (TDS) on the interest chargeable on the loan, as part of the employees’ salary. There are exceptions regarding taxation in certain cases as discussed below.

Method of Calculation

Step 1: Find out the aggregate outstanding balance of the loan(s) as of the last day of each month.

Step 2: Check for the interest charged by the State Bank of India (SBI) as of 1 April of the year in which the loan was taken as per the purpose for which such a loan was taken.

Step 3: Calculate the interest applicable to the loan amount for each month of the financial year. Use the loan amount found in Step 1 and the interest rate as per Step 2 to calculate this.

Step 4: Deduct the interest recovered by the employer from the total interest calculated in Step 3.

Step 5: The remaining balance is the taxable amount as ‘perquisite’.

Exceptional Case

If an employee of a company holds 10% or more of the company's voting power, any loan taken by that employee will be considered a deemed dividend under Section 2(22)(e) upon satisfying some conditions. However, even in such cases, the interest on such payout is still taxable as a ‘perquisite’.

When is the Loan Exempt from Taxes?

There are 2 cases when the loan is exempt from taxes:

• If the loan is taken for medical treatment of one of the diseases listed in Rule 3A, the loan is exempt from taxes. However, this is not applicable if the money is received as reimbursement under a medical insurance scheme. The reimbursement will be taxable as a ‘perquisite’.
• If the aggregate amount disbursed as a loan is within Rs.20,000, the loan is not taxable.

Responsibilities of Employee and Employer

The employer is required to calculate the value of the perquisite following the procedure laid down in step 2 above. Further, it is the employer's duty to include the ‘perquisite’ in the calculation of salary.

The employer is responsible for deducting tax on the ‘perquisite’ value and depositing the TDS with the government. If the employer fails to include the ‘perquisite’ in ‘salary’ or deposit TDS on the same, the employer would be liable for failing to deduct or deposit the tax.

In case of failure to include the ‘perquisite’ and failure to deduct tax at source, the employer is liable to pay interest @ 1% per month from the date the tax was deductible to the date the tax was actually deducted. In case of failure to deposit TDS, the employer is liable to pay interest at 1.5% per month from the date of deduction to the date of actual payment of the tax.

All taxable ‘perquisites’ are reported in Form 16 of the employee. The employee is responsible for reporting the ‘perquisite’ while filing their ITR. The ‘perquisites’ have to be reported under their income from ‘salary’. The employee can claim credit for TDS on salary while filing their ITR.

Example For Loan from Employer

Housing loan @ 6% per annum. The amount outstanding on 1.4.2023 is Rs.6,00,000. Shri Bala pays Rs.12,000 per month towards the principal, on the 5th of each month.

The lending rate of State Bank of India as of 1.4.2023 for housing loans may be taken as 10%

The benefit will be equal to the interest computed at the rate charged per annum by the State Bank of India (SBI) as of the 1st day of the previous year in which the loan was sanctioned. This rate should be applied to the maximum outstanding monthly balance, and the resulting amount should be reduced by the interest, if any, actually paid by him. “Maximum outstanding monthly balance” means the aggregate outstanding balance for the loan as of the last day of each month. 

The Perquisite Value for Computation is 10% - 6% = 4%