Tax Benefits On Business Loans In India

Synopsis: The interest paid on the business loan is tax-deductible under Section 80C of the Income Tax Act of 1961. This means that the interest paid can be deducted as business expenses when filing income tax. Read along to know more about the tax benefits on business loans in India.

A business loan is exactly what it sounds like — money you borrow from a financial institution to fund your company’s operations or growth. However, taking out business loans can weigh you down with excessive interest rates. To help mitigate this expense, you can claim a tax deduction for interest on business loans.

According to the Income Tax Act of 1961, you can deduct the interest you paid on a business loan from the profits earned by your firm. The Income Tax Act further emphasizes that business loans are not income from the firm through which you can earn profits.

In this article, we talk about business loans, types of business loans, and tax benefits on business loans in India in more detail. Read along!

Business Loans: Types, and Importance

A business loan is a sum of money that you borrow from a financial institution for financial purposes such as more investment, expansion, and so on. These loans assist businesses in meeting their immediate expansion and growth requirements.

Lenders assess the creditworthiness (your ability to repay the loan) of the business owner based on characteristics such as credit score and business turnover. However, entrepreneurs or business owners are legally required to use the loan amount solely for business costs and not for personal spending.

Type of Business Loans

There are several loans that you can take up to finance your business; some of the most common ones are:

• Term Loan: It has a loan term of 1–5 years, and is often used for capital expenditures. The loan amount depends on the credit history of the business.
• Startup Loan: These loans are based on expected turnover figures, offering funds for setup expenses once the business has established itself. It is ideal for new ventures without a credit history.
• Working Capital Loan: These help businesses address financial gaps in their day-to-day operations. They are especially helpful for businesses managing seasonal demands and cash flow fluctuations.
• Loan Against Property: Ideal for larger loan amounts, these loans are secured by property with a 10 to 20-year tenure, granting up to 70% of property value, but requires a mortgage.
• Invoice Financing: Businesses can raise money by using unpaid invoices as collateral, assisting in managing cash flow gaps caused by delayed payments.
• Equipment Financing: It’s beneficial for manufacturing businesses that want to secure use machinery as collateral to secure loans.

Business Loan for Women: These loans offer flexible terms, quick processing, and low interest rates to encourage women to start small or medium-sized businesses.

Business Credit Card: It’s a quick solution for short-term needs and offers benefits like cashback and insurance covers, though it’s best as a last resort since its interest rates are higher.

Importance of Business Loans

Business loans help you sustain and grow your business; following are some other reasons why business loans are important:

• Flexibility: You can apply for short-term or long-term loans, depending on your business's requirements.
• Expansion opportunities: These loans enable you to seize growth opportunities, whether by opening new locations, entering new markets, or launching new products.
• Funds Working Capital: You can use the business loan funds to boost your working capital, which can be extremely beneficial if you are experiencing a liquidity crisis.
• Crisis Management: Business loans serve as a safety net for your business during unexpected crises, helping it overcome financial challenges and maintain operations.

What is Business Loan Interest?

Interest rates are an expense a borrower must pay in exchange for borrowing money. The rates vary by lender and are classified as an expense since the loan funds are used for commercial purposes. As a result, you can claim tax deduction on the interest you pay.

How Tax Deduction Works?

According to Section 80 of the Income Tax Act, a deduction qualifies as a tax advantage you can use to lower your taxable income. A tax deduction is a sum that you can deduct from your taxable income to reduce the amount of taxes you owe.

It is calculated as:

Thus, the higher your deduction, the lesser your tax liability.

Tax Deductions on Business Loans

According to the Income Tax Act of 1961, you can claim a tax deduction on the business loan interest that you pay from your business's profits. Also, the I-T Act states that money used in the form of business loans is not the same as income, revenue, or profit earned by the business.

On the Principal Amount

The principal amount is the loan amount you get. It does not include interest on a business loan, business expenditure, or a portion of business expenditure.

As a result, the principal on a company loan is not tax deductible. It is not subject to income tax, and it cannot be deducted from your gross income. In most cases, you must pay tax on the financial year’s net income.

On the Interest Amount

The amount given back to the lender as interest is tax-deductible and can be written off as payments for company expenses. To determine your total taxable amount, you can subtract the total business expenses (total costs incurred to generate income) from the total revenue.

Tax deduction is a great way for small business owners and entrepreneurs to reduce tax liability and use the profits to expand their operations.

Types of Business Loans with Tax Benefits

All types of business loans, whether it is term loans, working capital loans, bill discounting, or micro-loans, are tax-deductible. In fact, even personal loans taken for business use are tax-deductible.

Borrowers must, however, take loans exclusively from recognized lenders, as loans from unrecognized or local moneylenders may not be eligible for tax benefits.

Conclusion

Business loans have both taxable and tax-deductible components. When you make payments against the loan principal, the earnings used remain taxable. In contrast, interest paid is considered a business expense and hence is tax-deductible.

It's easier to do business taxes if you keep track of the interest and ensure you don’t pay much more than you should.