Does Borrowing a Loan from a Friend or Relative Affect Taxes?
A personal loan is one of the easiest ways to meet financial needs, whether it's for medical expenses, home renovation, or other personal emergencies. While many borrowers approach banks or NBFCs, some prefer borrowing from friends or relatives due to flexible repayment terms and no strict eligibility criteria. However, one important question arises—does borrowing a loan from a friend or relative affect taxes? Understanding the tax implications of such informal loans can help you avoid legal issues and unnecessary tax liabilities.
Is a Personal Loan from a Friend or Relative Taxable?
A personal loan is not considered taxable income because it is a liability that must be repaid. However, there are certain tax rules and regulations that apply based on the nature of the loan, the repayment method, and the documentation involved.
Section 56(2) of the Income Tax Act
The Income Tax Act, 1961 states that if an individual receives a sum of money exceeding ₹50,000 as a gift, it will be treated as income and taxed accordingly.
However, a loan is different from a gift. As long as the borrowed amount is repaid and properly documented, it is not taxable.
If there is no repayment proof and the amount seems like a gift, the tax department may treat it as unexplained income, making it subject to taxation.
Key Tax Considerations When Borrowing a Loan from a Friend or Relative
1. Loan Documentation is Essential
To avoid tax complications, both the lender and borrower should maintain proper records:
Draft a loan agreement specifying the amount, repayment tenure, and interest (if applicable).
Mention repayment terms and any applicable interest rate.
Use bank transactions instead of cash to document the loan.
2. Interest-Free vs. Interest-Based Loans
Interest-Free Loan: If the loan is interest-free, the borrower does not have to worry about TDS (Tax Deducted at Source) or tax implications.
Interest-Based Loan: If the lender charges interest, it is considered income for the lender and must be reported under Income from Other Sources in the lender’s tax return.
The borrower cannot claim tax deductions on the interest paid unless the loan is used for business, home purchase, or education.
3. Purpose of the Loan Matters for Tax Deductions
The tax impact of a personal loan depends on how the borrowed amount is utilized:
Personal Use (Wedding, Travel, etc.): No tax benefits apply.
Home Purchase or Renovation: If the loan is used for home-related expenses, the interest paid may be deductible under Section 24(b).
Business Purposes: If the borrowed amount is invested in a business, the interest paid is deductible under Section 37(1).
Education Expenses: If used for higher education, tax benefits on interest paid may be available under Section 80E.
Does Borrowing from a Friend or Relative Attract GST?
The Goods and Services Tax (GST) does not apply to a personal loan from a friend or relative as long as they are not in the business of lending money. However, professional money lenders and NBFCs charge GST on processing fees and other charges.
Tax Risks of Taking a Personal Loan from Friends or Family
While borrowing from friends or relatives seems easy, it comes with some potential tax risks:
1. Unexplained Cash Deposits
If you deposit a large sum of borrowed money into your bank account without proof, it may be treated as unexplained cash credit under Section 68.
To avoid scrutiny, always ensure the loan is transferred through banking channels.
2. Gift Tax Issues
If a friend or distant relative provides financial assistance but does not require repayment, it might be considered a gift, which is taxable if it exceeds ₹50,000.
Gifts from close relatives (parents, siblings, spouse, children) are exempt from tax under Section 56(2).
3. Lender's Tax Implications
If the lender charges interest, they must report it as income and pay tax accordingly.
Failing to report interest income may lead to tax penalties.
How to Properly Structure a Loan from a Friend or Relative?
To avoid legal and tax complications, follow these best practices:
1. Create a Loan Agreement
Mention details like loan amount, repayment tenure, interest rate (if applicable), and repayment schedule.
Get the agreement signed by both parties and, if possible, notarized.
2. Use Banking Channels
Always transfer loan amounts via NEFT, RTGS, or cheque to maintain proof.
Avoid cash transactions above ₹20,000, as per Section 269SS of the Income Tax Act.
3. Maintain a Repayment Record
Keep a record of EMI payments or lump sum repayments.
The lender should also maintain records to report interest income in tax filings.
Comparison: Personal Loan from Banks vs. Friends/Relatives
| Feature | Bank/NBFC Personal Loan | Loan from Friend/Relative |
|---|---|---|
| Documentation | Requires loan agreement & KYC | Agreement is optional but recommended |
| Interest Rate | Fixed (10%-24%) | Flexible or interest-free |
| Tax Benefits | Available for home, business, or education | Depends on loan usage |
| Repayment Terms | Fixed EMI structure | Can be flexible |
| GST on Loan Processing | 18% GST on fees | No GST |
Common Myths About Borrowing from Friends or Relatives
Myth 1: No Documentation is Required
✅ Fact: Proper documentation is essential to avoid tax scrutiny.
Myth 2: Loan from a Friend is Always Tax-Free
✅ Fact: If interest is charged, it is taxable for the lender.
Myth 3: Large Cash Loans Have No Tax Implications
✅ Fact: Cash transactions above ₹20,000 can attract penalties.
Final Thoughts
Borrowing a personal loan from a friend or relative can be a convenient way to access funds without dealing with banks. However, tax laws must be followed to avoid complications.
A proper loan agreement ensures clarity for both parties.
Interest-based loans should be declared for tax compliance.
If used for business, home, or education, tax benefits may be available.
Always consult a tax advisor before taking or giving a personal loan to ensure compliance with the Income Tax Act. Proper documentation and adherence to tax laws can prevent future legal issues and financial disputes.
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