In case of financial hardship, it is not uncommon for people to take help from friends and relatives. Right now, due to the covid crisis, many people are facing financial stress due to job loss, pay cut or shut down of businesses. However, borrowing from or lending by a relative or friend is not a taxable transaction from an income tax perspective but there are certain other regulations that one should keep in mind while borrowing or lending, to avoid penalties.
In case you are borrowing from or lending to a person who may be your relative or friend, an amount more than Rs20,000, then it has to be transferred through an account payee cheque or a bank draft, or an electronic transfer through a bank account. The loan should not be given in cash or bearer’s cheque in case the amount is more than Rs20,000.
“Violation of the above empowers the income tax officer to levy a penalty to the extent of 100% of the amount involved," said Raghunathan Parthasarathy, associate partner, tax and regulatory services, BDO India.
Same regulations will apply in case of repayment. “Any repayment of loan amounting to Rs20,000 or more should be done through an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed, under Section 269T," said Shailesh Kumar, Partner, Nangia & Co LLP.
However, one should remember that the interest earned from the lending activity will be fully taxable. “Any interest charged by lender from any borrower (including a relative) is chargeable to income tax, generally under the head 'income from other sources'," said Kumar.
Also, in case you have borrowed money for construction or purchase of house, you can claim the tax deduction against the principal and interest repayment made. But you should keep certain documents handy in case of tax department query. “Loan agreement (you should have one even if borrowing from relative), calculations of interest and principal repayment during the year, bank statement to show payments," said Kumar.
Borrowing from or lending to NRI relative/friend
Apart from the above-mentioned income tax regulation for lending/ borrowing from friends or relatives, one should also comply with the requirements under Indian Exchange Control Regulations when borrowing from or lending to Non-Resident Indian (NRI) relatives or friends.
“An Indian can only accept rupee loans from non-resident Indians (NRIs) or a person of Indian origin and not from other non-residents. “The period of loan shall not be more than three years and the interest rate is restricted to 2% over the existing bank rate," said Parthasarathy.
Apart from this, an Indian resident can only take foreign exchange loans from his close non-resident relatives. “In this case, the amount of such loan cannot exceed $250,000 per year and the loan should be taken for at least one year and that too interest-free," said Parthasarathy.
An Indian resident can also lend to an NRI relative. This loan can only be given for a period of one year and the same shall be interest-free. The amount of loan is restricted to the limit under the liberalized remittance scheme, which is $250,000.