Is a loan from a friend taxable in India?

There was news that is good you. You will never be taxed at all.

A recent ruling by Income Tax Appellate Tribunal (ITAT) in the case of Chandrakant Shah stated that you nor the lender will have to pay tax if you borrow interest-free money from friends and colleagues neither.

This ruling was given because of the tribunal on 12th January 2009. Why don't we take a good look at how this ruling came into effect.

Just before 1997, one of the taxes that existed was Gift Tax. Depending on the rules associated with Gift Tax Act, the person lending the income to his acquaintances was taxed. As well as the tax rate here was exorbitantly high.

You finished up paying around 30 per cent regarding the value of the taxable gift. For e.g. in the event that value of the gift was Rs 1 lakh, you wound up Rs that are paying to the income tax department.

This made many individuals wary of lending money to their friends and colleagues. Even the recipients of these gifts are not spared. Because of this, many people did not utilize this good source of financing, despite the fact that their friends would not charge them any interest.

However, in 1997, gift tax was abolished. So both the donor along with the recipient did not have to pay any tax on the gifts received. Consequently, people started misusing the vacuum left out by the scrapping of gift tax. There was a transfer that is widespread of gifts from the non-relatives. In order to fill up this void, Section 56 (2)(v) of Income Tax Act was passed in 2004.

Any amount exceeding Rs 25,000 obtained by a person or a Hindu Undivided Family (HUF) without any consideration from non-relative could be taxed according to Section 56 (2)(v) of the Income Tax Act. The only cases exempted were the gifts given during marriage, the inheritance left behind in a will or if perhaps the payer has died.

When it comes to Chandrakant Shah, the assessing officer of income tax, used this section and considered the interest-free loans fond of Shah by his non-relatives as amount without consideration and taxed it.

This made Shah approach the Commissioner of I-T (Appeals) for relief, but failed. Subsequently, he appealed the Mumbai ITAT, and his lawyer argued that the law authorities made the interpretation that is wrong of the section.

Moreover, his lawyer argued that an interest-free loan does not fall within the purview of Section 56 (2)(v), considering that the loan repayment itself can be considered to be a consideration between both the parties rather than as a sum without consideration.

Also, Shah's balance sheet showed the amount as unsecured loan liability and so may not be seen as an addendum to your capital, that is true in case there are gifts.

He also referred to the judgment provided by the Court of Appeal of State of California, which stated that loan was a contract between two parties. According to this contract, one party lent money with another party, who then consented to repay the funds in future, with or without interest. His argument was upheld by the ITAT bench and thus gave the ruling favoring Shah.

Therefore the next time you are wondering whether or not to borrow the money from your friends and colleagues, go on and use this ruling to your benefit. There's no real way you'll be taxed.