Neither a borrower nor a lender be; for loan oft loses both itself and friend ." The advice by Polonius, the chief counsellor to King Claudius in Shakespeare's Hamlet, had good reasoning behind it.
A loan to a family member or a friend is usually unsecured. The terms and conditions are undefined or hazy and demanding payback can get awkward. If the loan goes bad, often, so does the relationship. Such a loan is also usually interest-free. If not returned, the lender simply loses the money.
Many people are thus wary of giving loans to relatives and friends.
But what if you draw up a legal document clearly defining the terms and conditions of the loan? In this way you avoid all misunderstandings: you can help your friend, as well as protect your interests.
There are two ways to do this - you can either take a promissory note from the borrower
or draw up a detailed loan agreement. Both are legally valid documents, recognised by courts in case there is a dispute.
"A promissory note is an acknowledgement to pay back debt - on demand or otherwise - and can include some simple terms and conditions," says Gurmeet Singh Kainth, Partner, D.H. Law Associates, a Mumbai-based law firm. If you want to keep things simple and only for the record, take the promissory note route - an unconditional promise by the borrower to pay a fixed sum on demand, or at a specified date.
The promissory note comes under Section 4 of the Negotiable Instruments Act, 1881, and has to be signed by the borrower. Such notes can vary in their phraseology - depending on whether there are single or joint borrowers, whether the lender wants the loan to be payable on demand, payable in instalments or as a lump sum, whether it carries interest or is interest-free. Though the basic format is the same, sentences can be added or tweaked to change the terms and conditions. A simple Google search will provide sample formats. Though not mandatory, it is better to draw up the note on stamp paper and get it notarised. Any notary - special judicial officer - will attest it for a small fee. "But if the aim is to include specific or detailed clauses, it is advisable to enter into a loan agreement," adds Kainth. Loan documents, however, have to be mandatorily drawn up on stamp paper and notarised. These can be worded just the way you want, including details relating to, say, the collateral offered if any, the consequences of a default, the conditions for terminating the loan, and the names of legal heirs, if necessary.
Words should be used with great care while drawing up such a document. Full names should be used as they appear in identity proof documents such as the PAN card or the voter identity card. and the date and place where the agreement is being signed mentioned clearly. Details such as the tenure of the loan, the periodicity of repayment (monthly, annually, in a lump sum or in instalments) and how the interest, if any, will be calculated (simple or compounded annually, etc) should be spelt out. The loan amount should be given through a bank cheque and the cheque number mentioned in the agreement.
Unlike promissory notes, loan agreement can be modified later. An amendment clause needs to be incorporated in the agreement. It enables the parties to amend the document on mutually agreed terms.
"Amendments can be carried out either through written confirmation or a supplementary agreement," says Kainth. There is no legal requirement but it is advisable to get the document signed by a witness, preferably someone not related to either of the two parties. This will hold weight if there is a dispute.
Interest-free loans are not taxable, no matter who they are given to or taken from. With gifts, it is different. Gifts from family members (as the 'family' is defined in the Income Tax Act) are not taxable, no matter how high the amount. But any gift above Rs 50,000 from a friend (anyone who does not fall in the ambit of 'family') is taxable. If your friend gifts you Rs 60,000, you have to pay tax on the amount, but if it is a loan that you will be paying back, there will be no tax on it.
However, if you seek interest on the loan you have given, the interest earned is taxed. Also, payments made to repay non-institutional loans - from private individuals, including friends and family members - are not eligible for tax deduction under Section 80C. That is, you will not be able to claim tax deduction on the principal. And even if it is from institutional sources, taxation will depend on the purpose of the loan.
"A loan taken to buy a house is eligible for tax deduction under Section 24 of the Income Tax Act, but you won't get any tax benefit if the money is for personal use," says Kuldip Kumar, Executive Director, Tax and Regulatory Services, PricewaterhouseCoopers India.
Courtesy: Money Today