India: Crystal Gazing of Home Loan Interest

"Tax planning is the legitimate right of every tax payer."

According to a recent study on tax administration, nearly an amount of Rs.15000 crores was disbursed by all the housing finance companies to nearly 4.5 lakhs loanees and nearly 59% of the new loanees availed loans less than Rs.5 lakhs and the average size of the loan is Rs.2.5 lakhs. The annual interest burden on such average loans would be around Rs.25000/-. Considering the fact that India’s per capital GNI was USD 450 at the end of 2001 according to World Bank statistics, this figure is really significant. Most of the taxpayer owners enjoy the incentive given for interest on home loans under the Indian Income Tax Act. It is believed that the annual interest burden on the average loan is in the region of Rs.75000/- to Rs.160000/- for those loanees who have availed loans between Rs.5 lakhs to Rs.10 lakhs and above Rs.10 lakhs respectively. Thanks to the interest rate war that is going on in enticing new customers amongst housing finance companies and banks, a lot of ignorance is noticed in understanding the proper tax implications on this tax incentive. This article attempts to clarify the correct position regarding the deduction of interest under the Indian Income Tax Act.

The interest on borrowed capital is an allowable deduction on an accrual basis if the capital is borrowed for the purpose of purchase, construction, repair, renewal or reconstruction of the house property. As the deduction is on accrual basis, the interest has to be claimed as a yearly deduction whether it is paid or not. The deduction is available even if neither the principal nor the interest is a charge on property. This deduction cannot be extended to penal interest or brokerage or commission for arranging the loan. The interest on a fresh loan taken to repay an earlier loan raised for the aforesaid purposes is allowable as a deduction. Any interest chargeable under the Act in the hands of the recipient and payable out of India, on which tax has not been paid or deducted at source, is not deductible.

Interest payable by an assessee pertaining to a period prior to the acquisition of the property or interest incurred during construction is not allowable in the year of payment. Such interest payments have to be accumulated and a deduction at the rate of 20% has to be claimed commencing from the previous year in which the house is acquired or constructed. In other words, the first instalment is deductible in the year in which construction of property is completed or in which property is acquired. The pre-construction period for this purpose would mean the period commencing on the date of borrowing and ending March 31^st immediately prior to the date of completion of construction / date of acquisition or date of repayment of loan whichever is earlier.

The interest on borrowed capital has been increased from Rs.75000/- for the assessment year 2000-2001 to Rs.1 lakh during the assessment year 2001-2002 and to Rs.150000/- for the assessment year 2002-2003 onwards. The interest on borrowed capital is deductible upto Rs.150000/- if the capital is borrowed on or after 01-04-1999 and the acquisition on c0onstruction is competed within three years from the end of the financial year in which the capital was borrowed as per amended section 24 (b).

There is no stipulation regarding the date of commencement of construction. Consequently, the construction of the residential unit could have commenced before 01-04-1999 but, as long as its construction / acquisition is completed within three years from the end of the financial year in which the capital was borrowed, the higher deduction of Rs.150000/- would be available. Also there is no stipulation regarding the construction / acquisition of the residential unit being entirely financed by the loan taken on or after 01-04-1999. It may so in part. However the higher deduction of Rs.150000/- towards interest can be claimed only in relation to that part of the loan which has been taken and utilized for construction / acquisition after 01-04-1999. In other words, the loan taken prior to 01-04-1999 will carry deduction of interest upto Rs.30000/- only.

If the capital is borrowed prior to 01-04-1999 or the acquisition or construction is completed after 01-04-2003, the interest on borrowed capital is deductible only upto a maximum of Rs.30000/-.

Due to the downward revision of interest rates, most of the loanees may be tempted to take a fresh loan to repay an earlier loan and may like to claim the twin advantage of a lower interest rate on the new loan and the enhanced interest deduction. In order not to be mislead, such decisions on swapping of high cost loan with low cost one should be taken bearing the above legal position in mind.

In most countries, the mortgage interest in respect of loans for acquiring owner occupied dwelling is not deductible. In India, the deduction is allowed as a social security measure and is aimed at working class and smaller taxpayers. According one line of thought, the aggregate of individual savings for old age income / medical security and housing may not be adequate to generate socially optimal levels of such social security assets and would therefore end up requiring state support due to their individual myopia and destitution. Considering the potency of such argument, the committee on tax administration has recommended interest rate subsidy on loans below Rs.5 lakhs or reduce the deduction on owner occupied house to Rs.50000/- from Rs.150000/-. However this is only of academic interest at this juncture.

The subsidy given by the Central Government in respect of "own your housing" scheme is aimed at giving a fillip to the housing sector and has a definite time frame in mind. Further it is targeted at those loanees who have availed loan after 01-04-1999 and those who have completed the acquisition / construction within a period of three years commencing from the year in which the loan was obtained. As this is more in the nature of an incentive, the conditions attached to the incentive must be complied with.

The author acknowledges the contribution made by Mr. R S Nambi, Senior Partner in developing this article.