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Loan / Gift : Income Tax query

Jeet Biswas (ACMA (in Service)) (5073 Points)

03 May 2010

If a non relative gives u a gift in excess of 50000/-, its taxable as "income frm other source"

How can one prove that The amount taken was LOAN; so that one can escape the IT dept.

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8 Replies

CA Ayush Agarwal (Kolkata-Pune-Mumbai) (27186 Points)
Replied 03 May 2010

Just Return Amount Through Banking Transaction.

It will Not Treated as Gift.

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Aditya Maheshwari (CA in Practice) (35867 Points)
Replied 03 May 2010

Take a letter from the person giving the loan that please find enclosed cheque of Rs. ___/- towards loan.

Issue a receipt for receipt of the loan amount.

Show the balance in the balance sheet under the head unsecured loan

Take a loan confirmation from the party you have taken loan from.

Pay interest at prevailing market rates

Take a copy of the balance sheeet from the party who has granted such loan to see that the same has been reflected in his books or not.

Take a copy of the bank statement of the party granting the loan to signify that loan has not been given out of cash deposit and the creditworthiness of the party is known.

manisha grover (CA Finals ) (61 Points)
Replied 04 May 2010

If u have taken a gift you may treat this either as unsecured loan or treat it as expenditure for work done by party who has gifted iff he/she is working and useful to you but on the same hand it will be taxable in hands of the party who has gifted the assessee.

if you want to treat it as unsecured loan then take the confirmation from the party grating a loan that a sufficent proof as it is unsecured loan but make the payment of the same via cheque/demand draft and pay the interest component on the same.

CA Dhiraj Ramchandani (CA, M. com) (10823 Points)
Replied 04 May 2010

Good afternoon Sir Aditya,

Just had a query, actualy don't know the treatment, so... What will be the effect if person seeks interest-free loan??

I mean u suggested to pay interest on the loan amount shown,. What if the person shows it as interest-free loan?? I think it won't be taxed and wont be considered as gift even???

Aditya Maheshwari (CA in Practice) (35867 Points)
Replied 04 May 2010

Dear Dhiraj

Your question has been answered in this ITAT judgement reproduced below where it has been held as follows:

Interest Free Loan from a non-relative is not liable to tax

Decided by ITAT Mumbai in the case of Chandrakant H. Shah v. ITO . Appeal No. ITA NO. 3966/MUM/2008 Decided on JANUARY 12, 2008.

In a first-of-its-kind judgement, the ITAT Mumbai recently ruled that a recipient of an interest-free loan from a non-relative is not liable to pay tax. The judgement will come as a major relief for people who borrow money from friends and colleagues and latter grapple with notices from tax authorities.

Section 56 (2)(v) of the Income Tax Act provides for taxing any sum of money in excess of Rs 25,000 received without consideration by an individual or a Hindu Undivided Family (HUF) from any source other than a relative. Occasions where the recipient is exempted from tax are during a marriage, or in cases where the amount is received under a will, or by way of inheritance or in contemplation of death of the payer.

Applying this section, an income-tax assessing officer treated interest-free loans amounting to Rs 54.7 lakh received by one Chandrakant Shah from non-relatives as a sum without consideration and taxed it.

The assessee approached the Commissioner of I-T (Appeals), but was not granted relief. He then appealed before the Mumbai ITAT, where his legal counsel said that the lower authorities had “misinterpreted” the new section, which came into effect on September 1, 2004. Furthermore, Mr Shah’s counsel said the sum of interest-free loans taken by him even before that date (September 1, 2004) did not fall within the ambit of the amended section.

Bhupendra Shah, Mr Shah’s counsel, argued before a division bench comprising Madhavi Devi and VK Gupta that an interest-free loan could not be taxed under Section 56 (2)(v), as the repayment of a loan itself is treated as consideration between two parties and not a sum without consideration. The counsel said the amounts were shown in the balance sheet by the assessee as unsecured loan liabilities, and, hence, could not be treated as an addition to capital as in the case of a gift.

The counsel contended that the term “loan” meant delivery by one party to and receipt by another party of a sum of money upon agreement expressed or implied condition, to repay it with or without interest. He maintained that it was inessential for an interest component to make a transaction of lending of money a loan transaction, by referring to a decision of the Court of Appeal of State of California. The US court had observed that a loan of money was a contract by which one delivered a sum of money to another, and the latter agreed to return at a future time without interest that sum which he borrowed.

The bench upheld the counsel’s argument, saying: “We hold that a transaction of loan can be without interest and a transaction of loan implies an agreement to repay the money that is borrowed, which also gives reply to the revenue’s query regarding the existence of the obligation to repay the money at the time of taking such loan.

Section 56 (2)(v) was introduced to fill up the vacuum created by the abolition of the Gift Tax Act in 1997, which was donor-based, meaning the giver of a gift was taxed. After the abolition, both donor and donee were exempt from paying tax, which led to several non-genuine gifts being introduced from non-relatives on a large scale. It was to deal with such purported gifts that the amendment was made.

So even if loan is taken interest free it will not be considered as a gift.

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CA Dhiraj Ramchandani (CA, M. com) (10823 Points)
Replied 04 May 2010

Ok, so that means rather than showing it as unsecured loan and paying interest, one can also show such amount as unsecured interest-free loan??

Thanx for replying sir...

Aditya Maheshwari (CA in Practice) (35867 Points)
Replied 04 May 2010

Yes you can do so but it is preferable to pay interest

Ritesh Jain (CA, CS in Job) (675 Points)
Replied 04 May 2010

HI,

good evening to all,

This is regarding loan vs gift.

Infact loan Vs gift can easily be answered but

What about interest-free loans?

What if you were to take an interest-free loan from a non-relative - say a close friend who would like to help you out but does not want to make it into a commercial transaction by charging interest. The absence of interest would make the transaction look prima facie as a gift given by a non-relative and hence taxable as per the above law.

Well.... don't jump into a decision, go through the facts of the decided case ,it will help u better understand the technical argument behind the case.

one Chandrakant Shah faced precisely such a situation. He had borrowed over Rs 50 lakh from close associates for buying a flat. Since the loan was interest-free, the assessing officer treated the transaction as a sum received without consideration and taxed it. Shah then approached the commissioner (appeals) but to no avail. Not someone who easily gives up, Shah then knocked on the doors of ITAT Mumbai.
Shah's counsel reportedly argued that an interest-free loan could not be taxed under Section 56 (2)(v) as the repayment of the loan itself was the consideration between two parties. By referring to a decision of the Court of Appeal of State of California, the counsel maintained that it was inessential that an interest component should exist to make a transaction of extending money a loan transaction.

The Tribunal bench concurred with Shah and stated that the law needs to be followed in letter as well as spirit. Both aspects needed to be considered. The loans had been shown by Shah in the balance sheet submitted along with the return of income as loans and the lenders had also confirmed the same as such. Thus, it was a clearly a case of loan transactions and not a case of gift as held by the assessing officer.

The bench further went on to rule that a loan transaction should be examined in the light of the provisions of section 68 and not under provisions of section 56(2)(v). Sec. 68 basically states that where a certain sum is found to be credited in the books of the taxpayer and the taxpayer can offer no explanation about the nature and the source thereof, the Assessing Officer may charge such sum to income tax as income of the taxpayer.

In the present case, it was clear to the bench that provisions of Sec. 68 were not applicable at all since all the requirements of that section i.e., identity; creditworthiness and genuineness of the transactions had been proved.

The bench wondered, if an interest-free loan cannot be added under section 68, how could it be added as income of the recipient under section 56(2)(v) of the Act? This type of addition would lead to a situation of having two provisions for charging one type of income, i.e., it would mean that the legislature has provided two charging sections i.e., Section 68 and 56(2)(v) for the same type of income.

When a specific provision exists in law for a particular thing, then that thing is liable to be examined thereunder only and if that item cannot be taxed under that provision, then, that thing cannot be charged to tax under other provisions of the Act, the bench said. For example, if an item falls under the head "Profits and Gains of Business or Profession," but if the same cannot be taxed thereunder for any reason, then, it cannot be taxed under any other head. Surprisingly, in the present case, it is not that provisions of Sec. 68 were not applicable at all, hence, the assessing officer invoked the provisions of section 56(2)(v). On the contrary when it was found that Sec. 68 was being satisfied, Sec. 56(2)(v) was sought to be invoked in a bid to tax the transaction one way or another. This was patently unfair to the assessee.