Interest-free loans to employees and tax implications

Perquisites in relation to an employee are the personal advantage gained by the employee during the course of his/her employment. It is the profit or gain incidentally made from employment in addition to regular salary or wages. Section 17(2) of the Income Tax Act, 1961 defines perquisite in an inclusive manner. It includes the following:

1. The value of rent-free accommodation provided to the employee by the employer.
2. The value of concession in the matter of rent in respect of any accommodation provided to the employee by the employer.
3. The value of any benefit or amenity granted or provided free of cost or at concessional rate in case of specified employees.
4. The value of any specified security allotted or transferred, directly or indirectly, by any person free of cost or at concessional rate to an individual who is or has been in employment of that person, such as ESOP (applicable only up to financial year 1999-2000).
5. Any sum paid by the employer in respect of any obligation which, but for such payment, would have been payable by the employee.
6. Any sum payable by the employer, whether directly or through a fund other than a recognised provident fund or approved superannuation fund or a deposit linked insurance fund, to effect an assurance on the life of the employee or to effect a contract for an annuity.

From the above it becomes evident that any benefit, concession or amenity given by an employer to his employee would take the form of perquisite taxable in the hands of the employee. One such interesting situation is that of interest-free loan or loan provided at concessional rate by an employer to his employee. The questions that come to our mind are:

1. Whether such benefit is really a perquisite?
2. Whether such benefit is taxable and if yes in whose hands would it be taxed?
3. What rate of tax would be attracted?

The answers to these questions could be found in the various decisions delivered by high courts and the Supreme Court. It could definitely be argued that loan given by an employer free of interest or at concessional rate would endow benefit to the employee, which otherwise would have been borne by such employee. Let us take an example to get a clear idea.

Ram Leela Limited has introduced a loan scheme for its employees wherein employees are eligible to avail of loan dependent on their grade in the organisation. Damodhar Shyam is eligible to a loan limit of Rs 1 million, which he avails for the purpose of acquiring a house. The rate of interest charged by the company from its employees is 2 per cent per annum on reducing balance basis. In this context the assessing officer going through Damodhar's income tax return feels that the difference between the rate charged by Ram Leela Limited (i.e. 2 per cent) and the minimum rate fixed by the government (i.e. say 9 per cent) is chargeable as Damodhar's salary income (i.e. value of perquisite).

Such a case came up for hearing at the Madras high court where the judge felt that the same was definitely in the nature of perquisite given by the employer to the employee and, hence, the assessing officer was right in including the same as the employee's salary income. At the same time, however, other high courts such as the Karnataka high court decided in favour of the employee specifying that the same was not in the nature of perquisite and, hence, not chargeable to tax.

This confusion was prevalent for a long time and each AO used verdicts that were convenient to complete his/her assessment. The confusion was put to rest by the Supreme Court in its verdict in the case of V M Salgaocar & Bros, wherein it decided that the benefit arising due to interest-free or loan at concessional interest to the employee is not taxable as perquisite.

Let us go a step ahead to see if the end use is relevant to extend the Supreme Court verdict.

Ram Leela Limited decided to give loan to its employees so that the loan amount would be placed with a co-operative bank as fixed deposit, wherein the employee earned 12 per cent interest and paid the company 2 per cent ensuring that the employee earned a clear 10 per cent. Now the AO said that in this case he would tax the net interest income under the head "Income from Other Sources" and also include the differential interest earned by the employee as perquisite chargeable under the head "Salary Income".

In the verdict given by the Supreme Court in V M Salgaocar & Bros, the apex court also specified that the verdict remains unaltered whether the loan was given for house construction or for some other purposes. Hence, it is amply clear that regardless of the end use of the loan, any concession with regard to such loans given by the employer to his employee is not a perquisite chargeable to tax.

The above is made very clear by the chairman of Central Board for Direct Taxes in his letter to the chairman of the Standing Committee of Public Enterprises, wherein he clarified that it was never the intent of Parliament to enact a proposition inserted in the Taxation Laws (Amendment) Act, 1984, to tax such benefit as perquisite as this proposition was deleted in the Finance Act, 1985.

He further stated that in case it is observed that there is misuse on a large scale, then such benefit might be brought to tax by future amendments.

Another aspect not yet addressed by the Supreme Court is that of the subsidy granted by employers to their employees in respect of loan borrowed by employees from any outside agency.

Assume that Damodhar Shyam has taken a loan from HDFC for the purpose of acquiring a flat in Bombay at 12.75 per cent p.a. and Ram Leela Limited has decided to reimburse 85 per cent of the interest paid annually by Damodhar to HDFC. Is this subsidy chargeable to tax?

The verdict given by the Karnataka high court specifies that such subsidy too is not taxable. Though the apex court has not taken a firm stand on this aspect, it has definitely looked favourably at the Karnataka high court decision. Hence, it would be worthy to be cautious on this aspect till there is a firm judgement by the apex court.

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