ATM :: Home loan prepayment, processing charges are tax exempt


A recent tribunal decision has confirmed the fact that prepayment charges are an allowable deduction.
Gautam Nayak | First Published: Wed, Jun 26 2013. 07 10 PM IST | Live Mint

ATM

Most taxpayers are aware of the fact that interest on a housing loan is an allowable deduction. But few taxpayers know that even prepayment or foreclosure charges paid on premature repayment of housing loans or processing fees paid at the time of sanction of the loan are also allowable deductions in computing income from house property. A recent tribunal decision has confirmed the fact that prepayment charges are an allowable deduction.

On what basis are the prepayment or foreclosure charges regarded as an allowable deduction? The answer lies in the definition of “interest” under the income tax laws. It is a very broad definition, including not only interest payable in any manner in respect of money borrowed or debt incurred, but also includes any service fee or other charge in respect of the money borrowed or debt incurred or in respect of any credit facility which has not been utilized.

Therefore, when it is provided that interest is allowable as a deduction, not only would the actual interest paid be allowable but also any fees or charges in relation to the borrowing would be allowable.

What is a prepayment or foreclosure charge? It is a charge levied by the lender (the bank or the housing finance company) for the borrower repaying the loan earlier than as stipulated in the loan agreement. By making such early payment, the borrower effectively reduces his future interest outgo, which would otherwise have been allowable as a deduction. Therefore, the prepayment or foreclosure charge is clearly linked to the future interest which the lender has forgone and which the borrower saves. It is clearly a service charge in respect of the money borrowed, and in a sense, a charge for not utilizing the credit facility in the future. Therefore, as rightly held by the tribunal, such prepayment charge is also an interest on the housing loan and is, therefore, an allowable deduction. It is therefore important that one considers such prepayment charge as a part of the interest paid on the housing loan in the year in which such prepayment charge is paid.

What about processing fee paid at the time of getting the loan sanctioned? This is a fee charged by the bank or the housing finance company to process your loan application, and is therefore clearly linked to the loan sanctioned to you. This is also a service fee in respect of the money borrowed, and therefore clearly is in the nature of interest on the housing loan. Therefore, in the first year in which the loan is taken, one should consider not only the actual interest paid on the loan for the purposes of deduction, but also the processing charges paid to the bank or housing finance company as a part of such interest, which is considered for the purposes of deduction in computing income from house property.

Can one claim a deduction for the processing fee paid even if the loan is not ultimately sanctioned or utilized? The definition of interest makes it clear that the service fee or charge has to be in relation to the money borrowed or debt incurred. If no money has been borrowed ultimately, nor has any debt been incurred, but merely processing fees have been paid, such processing fees cannot be regarded as having been incurred in relation to money borrowed and therefore would not qualify as interest eligible for deduction in computing house property income.

Also, in case of processing fee paid for sanction of a housing loan for acquisition of a house property which is under construction, the processing fee would not be allowable as a deduction in the year of payment, but, along with the pre-equated monthly instalment interest paid during that year, would be accumulated till the year in which possession of the house is taken, and be allowed in five equal instalments over that year and the next four years.

Particularly in relation to prepayment charge, one needs to keep in mind that the total deduction allowable for interest on a self-occupied house property, the income from which is taken as nil, is restricted to Rs.1,50,000. This annual limit will apply to the total of the interest actually paid as well as the prepayment charge paid, and therefore if the total of these two exceeds the limit in that year, the benefit would be restricted to Rs.1,50,000.

Of course, of late, banks and housing finance companies are not permitted to levy prepayment or foreclosure charges on floating rate housing loans. You may therefore not get any extra deduction in such cases, because there is no charge levied. Do not be disappointed. It is far better to save the entire charge and not save tax, rather than pay the entire charge and get only a 30% tax deduction—you still save the 70%.

Gautam Nayak is a chartered accountant.

Source : http://goo.gl/tK1Sa

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