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56[2] *********************Purported gift vs interest free loans!!!!!!!!

Started by CA.BHUPENDRASHAH, June 29, 2008, 10:24:58 AM

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can AO add "interest free loan" received by assessee as " any sum received u/s 56[2] after 1-9-2004?

ashutosh majumdar

Hi Bhupendra,

Section 56 (2) (v) provides that any sum of money received "without consideration" may be assessed as income subject to certain exceptions.

"Money received without consideration" means a gift. A loan would never constitute "money received without consideration" because the consideration for a loan is the obligation to repay the same with or without interest on demand or on the expiry of a time period.

Even notional interest cannot be assessed as held in a number of judgements though it may attract transfer pricing implications if it is between associated enterprises.

Hope this clarifies the position.




It is necessary to ensure perfect documentation in case of an interest-free loan because it is difficult to distinguish between a gift and interest-free loan. 

Bhavesh Savla

Keep smiling.




Correct Bhupendraji

Gift goes to capital a/c and Loan goes to Current Liabilities.
But the question was if the AO can tax Interest-free loan  as Gift Income? If you have some proof that the transaction was indeed a loan amount and have sufficient documentation then the AO can never treat it as Income.

Ideally at least keep some nominal amount of Interest such that the TDS provisions are not attracted and the assessee is safe because then nothing will happen to treat it as a Gift.

Bhavesh Savla
Keep smiling.   


I dont buy the argument that a concessional rate of interest can take you out of gift.If interest free loan is gift in the opinion of AO, the concessional will also be so. One has to fight on the basic premise citing indian contract act which defines consideration. A gift is always without any consideration. The repayment on demand is always the consideration for an interest free loan.How can one establish that it is loan and not gift. First is the accounting treatment and second is the disclosure in balance sheet. I would advise to execute a demand promissory note for this purpose. In any case the additions made by AO on this count are in my opinion not sustainable.


The provisions of section 56(2) will not apply to intrest free loan as it is very rightly said that it comes with the obligation to repay it. In case the AO is suspicious about the genuineness of the loan he has been given enough powers under section 68 of the Act. Therefore he should not have any reasons to apply section 56(2) in such matter as the deeming provisions has to be consrued strictly. In case it is assumed that the contention of the AO is correct then it should be applicable to all the loans whether they are secured/unsecured/interest bearing/interest free.



sivaiah G

I also support the argument that loan cannot be added u/s 56(2). Some AOs have already added the same donot conclusively establish the legal position. The addition is bound to be deleted by higer appellate forums. Sec. 56(2) is intended to tax the purported gifts which will be used to increase the capital. Here in the instant case, the capital is not increased. If the loan is proved with a confirmation and the loan giver stands to the test of appeal, the same cannot be added on the plea that no interest is charged on it. In my opinion, AO donot have the power as to how the assessee should run his business in other words whether the assessee should take a  interest bearing loan or a non interest bearing loan. Only when the said loan is written off  and credited to capital then as per the explanation inserted in 41(1) it can be taxed during the that year. Some argue that the loan which is received on capital account cannot be taxed even u/s 41(1). But in my opinion, it can be taxed. Ultimately, my conclusion is that unless, the loan is written off, it cannot, in any way, taxed in the hands of the assessee.


Please name the case law.
Which ITAT?

Bhavesh Savla
Keep Smiling.