No tax exemption on concessional or interest free loan from the employer, not even for bank employees, says SC

May 21, 2024

Synopsis
Tax on concessional interest rate loan: The Supreme Court of India has stated that bank employees have to have income tax if they have availed loan from their employers at concessional interest rate or interest free rate. However as per our calculations, even if bank employees pay income tax on this loan, they will still have some savings.

Employees who receive a loan at a concessional interest rate from their employer are required to pay income tax. This practice is most common in banks, making bank employees the most affected group due to this rule. However, the All India Bank Officers Confederation felt differently about this and decided to challenge the constitutional validity of the income tax rule which imposed tax on loans given to employees at a concessional interest rate.

Employees (including bank employees) have to pay income tax on the difference between the interest rate of loans availed by them from their employer and the prime lending rate of the State Bank of India (SBI). The prime lending rate of SBI is usually significantly higher than the actual interest rate at which borrowers typically get a loan. The bank officer's confederation also challenged the reference taken (prime lending rate of SBI) for such a calculation.

However, the Supreme Court declared the rule to be valid, and that it is bound to impact a large number of employees who get the loan at concessional interest.

Here is a look at how this SC decision will impact your tax outgo if you are an employee has availed of a loan at a concessional rate from your employer.

What did Supreme Court say about taxability of concessional or interest free loan availed by bank employees

The origin of this issue was the amendment in the Finance Act, 2007 through a circular in July 2007. The All India Bank Officers Confederation, via a circular dated February 23, 2017, said that their affiliates and other unions had filed joint Writ Petition (Number 10053) in 2008 in the Madras Hight Court. "This Petition was filed seeking a declaration/order that amendments to Section 17(2) of Income Tax Act, 1961 as amended by Finance Act 2007 and also Circular dated 16.07.2007 was unconstitutional and void," said the Confederation in the circular.

However, the High Court judgement was not in favour of the bank employees, so they took their fight to the Supreme Court. The apex court delivered its judgement on this prolonged case in May 2024.

According to Dr Suresh Surana, founder, RSM India, "This Supreme Court judgement upheld the taxation of interest-free or concessional loans given by banks to their employees as 'fringe benefits' and 'perquisites' under Section 17 of the tax law wherein the interest charged by the bank on such loans is lesser than the interest charged according to the Prime Lending rate of the SBI. This decision reaffirmed the validity of Rule 3(7)(i) of the Income Tax Rules, which determines the taxation of interest-free or concessional loans as perquisites."

Why did the Supreme Court make concessional or interest free loans taxable for bank employees

As per the Supreme Court, the only reason banks offered concessional interest rates was because the loan takers were its own employees.

According to Deepashree Shetty, Partner, Tax & Regulatory Services, BDO India, "The Apex court pronounced that any fringe benefit or amenity incidental to employment and in excess of or in addition to the salary is an advantage or benefit given because of employment, which otherwise would not be available. Therefore, it is taxable as a 'perquisite' as per Section 17(2)(viii) of the Income-tax Act, 1961 under the Salary heads of income."

However, as per calculations, even if bank employees have to pay tax on the concessional interest rate loan availed by them, they will still end up saving money in certain conditions.

How will the taxable perquisite value be calculated for employees?

Rule 3(7)(i) of the income tax rules explains how to calculate the benefits of interest-free or concessional interest loans provided by employers to their employees. As per Surana, Rule 3(7)(i) is also applicable for bank employees (after this Supreme Court) judgement and the difference in interest rate shall be taxable as perquisite.

Here's a table showing the calculation of perquisite in a case where the loan outstanding is Rs 50 lakh and the employee is paying 6.15% interest rate, which is 3% lower than the home loan interest rate that SBI offers to borrowers with CIBIL score above 750, whereas SBI's prime lending rate is 15%.

(All figures in the table above are for representation purposes only) Source: Dr. Suresh Surana, founder, RSM India

How will banks employees save on interest cost if concessional loan is taken and tax is paid on it

The Supreme Court judgement has not commented on whether banks will stop offering concessional interest rate loans to its employees, as it comes under the Reserve Bank of India's purview.

"As per the RBI's Master Directions and other internal regulations, the Banks are free to decide interest rate for its employees. Hence, this judgement may not impact home loan or any loan interest rate but the difference between SBI prime lending interest rate and employee's rate will be taxed as a perquisite in the hands of employees," says Shetty.

In Table 1 (cited below), the loan amount is Rs 50 lakh with 9.15% being the interest rate offered to outsiders and 6.15% interest rate being offered to bank employees. The prime lending rate of SBI is 15%.

Here's a table showing how much income tax will be payable due to this judgement.

Table 1: Tax calculations (Old Tax Regime)

The tax payable columns in this table do not account for marginal relief, surcharge. and health and education cess. All figures in Indian Rupees. Source: Deepashree Shetty, Partner, Tax & Regulatory Services, BDO India.

The second table shows how much interest savings the bank employee is making due to the concessional interest rate. In this table, the interest rate for others is taken as 9.15% and the concessional interest rate is taken as 6.15%. The net interest savings is Rs 1.5 lakh.

Table 2: Interest savings comparison

Source: Deepashree Shetty, Partner, Tax & Regulatory Services, BDO India.

Let us now compare the two situations: one where the employee took a concessional interest rate loan and the other where he/she did not take it.

Situation 1: Employee with Rs 10 lakh taxable income takes a 6.15% concessional interest rate loan

Total tax liability factoring the perquisite value of concessional interest rate loan: Rs 2,45,250.

Total loan interest amount outgo: Rs 3,07,500

Net income: Rs 10,00,000-2,45,250-307,500= Rs 4,47,250

Situation 2: Employee with Rs 10 lakh taxable income takes loan at market interest rate of 9.15%.

Total tax liability: Rs 1,12,500

Total loan interest amount outgo: Rs 4,57,500

Net income: Rs 10,00,000-1,12500-4,57,500= Rs 4,30,000

Net Benefit in Situation 1: Rs 4,47,250 - Rs 4,30,000 = Rs 17,250.

Hence,, if this employee accepts the concessional loan interest rate offer and pays income tax on the perquisite value of this fringe benefit, he will save Rs 17,250.

When is concessional loan interest given by employers not taxable in the employee's hand?

Rule 3(7)(i) of the Income-tax rules is applicable to every type of loan availed at a concessional rate by the employee from its employer.

As per Surana, "the loan availed on a concessional rate will not be chargeable to tax under the following two cases:

> If a loan is made available for medical treatment in respect of diseases specific in rule 3A. The exemption is, however, not applicable to so much of the loan as has been reimbursed to the employee under any medical insurance scheme.

> Where the amount of original loan(s) does not exceed (in aggregate) Rs 20,000."

[The Economic Times]