As a payroll service provider, we verify the supporting documents submitted by employees when they seek tax benefit. If an employee seeks deduction under Section 24 of the Income Tax Act, for the housing loan interest, we typically seek a certificate from the bank/financial institution which presents the loan principal and interest schedule for the year, property construction completion certificate from the builder or employee declaration to that effect, proof of property ownership, etc. What we do not seek from the employee is proof of loan interest payment by way of, say, bank passbook copy.
Is proof of loan interest payment not important?
An employee need not have paid the interest to the bank/financial institution in order to claim tax benefit under Section 24. We find that many payroll managers are under the mistaken notion that an employee should have made the interest payment and the employer should be verifying the same by checking the bank passbook etc. as proof of interest payment.
The employer needs to verify only the total interest payable (not paid), by checking the loan statement from the bank/financial institution. As long as an employee has a valid housing loan, he can claim tax benefit on the interest for the year, whether or not he makes the interest payment to the bank/financial institution.
Why? Because Section 24 says so.
As per Section 24 of the Income Tax Act:
(b) where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital, the amount of any interest payable on such capital:
Provided further that where the property referred to in the first proviso is acquired or constructed with capital borrowed on or after the 1st day of April, 1999 and such acquisition or construction is completed within three years from the end of the financial year in which capital was borrowed, the amount of deduction under this clause shall not exceed 9[two lakh rupees].
As you can see from the above, Section 24 refers to interest “payable” and not the interest actually paid by an employee. The amount of annual interest payable can be considered for deduction every year. It does not matter whether the interest has been actually paid or not paid during the year.
Circular No. 363, dated 24.06.1983
The Income Tax Department issued a circular (No. 363) in 1983 which deals with an issue pertaining to housing loans provided to central government employees. As per the House Building Advance Rules of the Central Government of India, the recovery of the principal (on housing loan provided to government employees) is made first in not more than 180 monthly installments and then interest is subsequently recovered in not more than 60 installments. This means that while interest on housing loan accrues in the first 180 installments, the deduction/payment of the accrued interest starts only after 180 months.
The circular clarifies that in the period (say, the 1st year of the loan) when interest accrues but is not paid, the benefit under Section 24 is available. According to the circular:
Since the word used is ‘payable’, deduction under section 24(1) (vi ) would be on the basis of accrual of interest which would start running from the date of the drawal of the advance.
House property loan interest, accrued but not deducted/paid, is somewhat unique to loan provided by the government. Employees, when they take a housing loan for property acquisition/construction from banks/financial institutions, will need to pay interest as soon as it falls due. However, even when employees do not pay interest on time, they can claim tax benefit if the interest payment falls due in the year.
Applicability of the circular to non-government employees
While the circular answers a specific question on loans offered by the Central Government, its pronouncement on the matter of interest payable versus paid should be construed as being applicable to all assessees and not just the Central Government employees. Section 24 of the Income Tax Act applies equally to all assessees and there is nothing in law which states that a different text for Section 24 should be used for private sector employees.
This issue has also been settled by the court. In the case of CIT v. Devendra Brothers & Co. 200 ITR 146, the Allahabad High Court has stated that as long as the interest in respect of the housing loan has fallen due, the amount of interest whether it is paid or not would be a permissible deduction. According to the judgement, “if the amount of interest sought to be deducted had fallen due or a liability in that regard had been incurred in the previous years relevant to the assessment year in question, whether factually the amount of interest is paid or not, it is a permissible deduction” under the Income Tax Act in computing the income chargeable to tax under the head “Income from house property”.