Interest-free Loans under the Fringe Benefit Tax

The interest-free loans from employers have been settled down under the "Fringe Benefit Tax" (FBT). The subject of taxation of interest-free loans to employees has been under discussion and finally the issue has been settled down. From so many years these loans carried no tax liability because the income tax (IT) department gave the employers the complete deduction on the interest paid to the bank on borrowed money. In spite of this fact some part of these borrowing is being used to make interest-free loans to the employees.

Usually, all businesses borrow from banks by way of overdraft or cash credit for their working capital requirements. On such loans, businesses (employers) have to pay interest to the banks. This interest payment is fully tax deductible for incoming at the net taxable income. And this relief is extended to the companies, even when they divert a part of these borrowings for paying out loans to employees.

Change in the Law – Attempt One
In 1984 the Taxation Laws (Amendment) Act, for the first time tried to make interest-free loan as a “perquisite" under section 17 of the Income Tax (IT) Act, 1961 with effect from April 1, 1985. But the Finance Minister withdrew the proposed amendment with a view to avoiding adversity to the employees, if the interest-free loans were to be subjected to tax as privilege. Even the Supreme Court in the year 2000 held that there was no element of perquisite, merely because the loan did not carry any interest (in the case of V M Salgaokar & Bro.), thereby upholding similar judgments by the high courts of Kolkata and Karnataka.

Attempt Two
This situation remained for the employees for a short time because from assessment

year 2002-2003, the Central Board of Direct Taxes (CBDT) was empowered to frame rules for valuation of benefit accruing to employees as a result of such loans from employers. The said rule 3(7)(i) for ready reference reads something like this:

The value of the benefit to the assesses or any member of his household resulting from the provision of interest-free or concessional loan for any purpose given by the employer shall be calculated as the sum equal to the interest computed at the rate charged for the year by the State Bank of India for a similar loan. However, no value would be attached if such loans are made available for medical treatment in respect of diseases specified in rule 3A or where the amount of loan does not exceed Rs 20,000.

Clearly, the IT department has been interested in charging some value to the interest-free loans being offered by employers. And for medical treatment, only loans for diseases or ailments set in the Income tax rules (rule 3A) are eligible for the requisite exemption. However, this list is fairly comprehensive and includes several commonly encountered medical problems like those of eye, ear, nose and throat, besides the more serious ones like mental disorder, cancer, heart, tuberculosis and others.

Under the FBT
The Finance Act, 2005 has introduced a new Chapter in the IT Act, called the "Fringe Benefit Tax" (FBT). This tax is imposed on value of perquisites provided by employers to their employees. But with regard to FBT on interest free/concessional loans to employees, the FBT makes it clear that employer will not have any tax liability. For loans above Rs 20,000, the employees will be taxed under Income Tax Act.