Tax benefits on business loans in India

Tax benefits on business loans in India
Tax benefits on business loans in IndiaTax benefits on business loans in India

In India, opting for a business loan offers several advantages, one of which is the associated tax benefit. As per Section 36(1)(iii) of the Income Tax Act, 1961, the interest payment on borrowed capital is eligible for deduction from the income base.

The taxable income base is subject to tax slab percentages. By reducing the taxable income base through such deductions, the resulting effect can significantly diminish the tax liability for any business entity.

When it comes to claiming tax benefits outlined in various sections of the IT Act, uncertainties can arise regarding whether to seek benefits for the interest or the principal amount.

In the end, the borrower is responsible for repaying both the borrowed principal and the interest. Business loans are typically repaid through Equated Monthly Installments (EMIs).

Numerous sections of the IT Act offer tax advantages for expenditures or investments undertaken by businesses. These benefits should be applicable even if the investments and expenditures were financed through borrowed funds.

Therefore, the business should be entitled to claim benefits for both the interest and the principal components of the business loan, provided the specific conditions stipulated by the IT Act are met.

Sections of Income Tax Act, 1961 and tax benefits for business

Having a clear grasp of the relevant sections governing the taxation of business incomes in India is pivotal to optimizing tax benefits on business loans in India. The following sections within the IT Act are particularly relevant, as they pertain to deductions and taxation benefits for business entities:

Deductions applicable against profits & gains from profession or business:

Below are the descriptions and applicable sections within the IT Act of 1961 that pertain to deduction and taxation benefits for various types of business entities:

  1. Section 30: Covers expenses related to premises such as rates, rent, taxes, repairs (excluding capital expenditure), and insurance for all business entities.

  2. Section 31: Encompasses expenses linked to plant, machinery, and furniture repairs (excluding capital expenditure) and insurance for all business entities.

  3. Sections 32(1)(i), 32(1)(ii), 32(1)(i)(a), 32(1)(ii)(a): Relates to depreciation for power generation, distribution, and manufacturing across all business entities.

  4. Section 32AC: Offers investment allowance at 15% of actual cost for new asset purchase or installation in manufacturing and production.

  5. Section 32AD: Provides investment allowance at 15% of actual cost for investment in plant and machinery in manufacturing businesses within designated backward areas.

  6. Sections 33A, 33AB, 33ABA: Pertains to development allowances at 50% and other tax benefits for businesses related to tea, coffee, rubber, and petroleum/natural gas extraction.

  7. Sections 35(1)(i), 35(1)(ii), 35(1)(i)(a), 35(1)(ii)(a), 35(1)(iii), 35(1)(iv), 35-2, 35-2AA, 35-A, 35-AB, 35ABA, 35ABB, 35AC: Allows deductions up to 200% for scientific research, establishment of institutions/colleges, projects for rural development, conservation, agricultural extension, afforestation, skill development, payments to national labs, IITs, public sector companies, local authorities, technical knowhow acquisition, telecommunication services spectrum, and licenses.

  8. Section 36(1)(iii): Addresses interest on borrowed capital for all entities.

  9. Sections 36(1)(ib), 36(1)(ii), 36(1)(iii)(a), 36(1)(iv), 36(1)(iv)(a), 36(1)(v), 36(1)(v)(a), 36(1)(vi) - (xi), 36(1)(xii)-(xvii): Cover insurance premiums, employee bonuses/compensation, contributions to PF, PS, GF, bad debts, special resource fund transfers, family planning promotions, taxes paid, and more for various entities including government entities and cooperatives.

  10. Section 37(1): Encompasses other business/profession-related expenditures (excluding personal/capital expenditure and expenses mentioned in sections 30-36) for all entities.

Understanding these sections facilitates businesses in optimizing tax benefits as per the IT Act's provisions.

Income tax filing for business/professional entities

When filing income tax for business/profession-related earnings, ensure the following steps are taken:

  1. Select the correct filing form corresponding to your business/profession category.

  2. Utilize all relevant tax deduction benefits available under the relevant IT sections.

  3. Apply all pertinent tax exemption benefits provided by the applicable IT sections.

  4. Deduct any taxes already paid, including TDS, advance taxes, GST, and other applicable taxes.

  5. Implement any available rebates wherever they are applicable.

IT Act 1961 Section 36 1 iii scope and limitations

The scope and limitations of tax benefit claims by business entities under Section 36(1)(iii) of the IT Act 1961 can be encapsulated as follows:

Tax benefit on interest vs. tax benefit on principal

Business entities qualify for deductions contingent on their business type, nature, and structure. Provisions within Sections 30-37 of the IT Act outline criteria for business eligibility concerning deductions, exemptions, rebates, and other benefits linked to business loans in India.

For instance, Section 32AC offers a case in point. If a business entity invests in acquiring a new asset, it is entitled to a 15% investment allowance, subject to specific conditions. This allowance is calculated based on the actual investment cost of the new asset.

Consider the scenario of a business entity eligible under Section 32AC for investment allowance. This entity can claim investment allowance on the actual cost of the new asset at the time of purchase. Should the entity utilize borrowed funds for the asset acquisition, it is qualified to claim tax deduction benefits for the interest paid on these borrowed funds, as stipulated in Section 36(1)(iii). Furthermore, the entity has the eligibility to seek investment allowance benefits under Section 32AC for the principal amount paid in the respective financial year. This principal amount corresponds to the actual cost of plant and machinery.

Tax deduction benefit on borrowed capital against EMI payment

EMIs encompass both principal and interest payment segments. Entities have the option to request the lending institution to itemize these components, i.e., interest and principal. Importantly, the principal and interest components receive distinct tax treatments under varying sections of the IT Act. A business entity becomes eligible for diverse tax benefits as outlined in different sections of the IT Act.

In the context of EMI payments, the business entity doesn't confront a lump-sum expenditure for the principal amount. This nuanced approach affects the process of claiming deduction benefits associated with the principal part, such as under Section 32AC. In essence, while filing IT returns and aiming for deduction benefits linked to the principal payment, such as those under Section 32AC, the entity can potentially leverage investment allowance on the principal amount disbursed in the given financial year.

However, it is prudent to seek counsel from a business tax consultant prior to the conclusive submission of Income Tax Returns (ITR). This step ensures comprehensive understanding and adherence to the appropriate regulations.

Type of business entity

Under Section 36(1)(iii) of the Income Tax Act 1961, tax benefits pertaining to business loans in India are accessible to all assesses. This provision extends the privilege of claiming deductions for interest on borrowed capital to any kind of business entity that files income tax returns.

Exceptions for claiming tax benefit u/s 36 1 iii

When a business obtains funds for the purpose of procuring a capital asset, the Tax Deductible Business (TDB) towards the interest paid can be asserted starting from the time when the asset becomes actively utilized within the business operations. Conversely, if the capital asset has not yet been utilized for business purposes, the TDB, as applicable under Section 36(1)(iii) for interests paid on borrowed capital, cannot be claimed.

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