How to Show Loan from Friends and Relatives in Income Tax Return?

This article explains the Federal Board of Revenue (FBR) regulations regarding loans taken from friends and relatives in Pakistan, focusing on avoiding tax complications and correctly reporting these loans in the FBR’s IRIS system.

Key FBR Conditions for Validating Loans:

The FBR has established three key conditions to prevent loans from being treated as income:

1. Lender’s NTN/CNIC: The lender must have a valid National Tax Number (NTN), which for individuals is now their Computerized National Identity Card (CNIC) registered with the FBR. Simply put, the lender should be registered with FBR for filing returns. Filer or non-filer status of the lender is irrelevant.
2. Banking Channels: The loan transaction must occur through banking channels. Acceptable methods include online transfers, pay orders, and cheques. Cash transactions are not acceptable. Other methods like demand drafts are also valid.
3. Loan Evidence: Proper documentation of the loan is mandatory. This includes copies of cheques, bank statements showing the transfer, or any other proof of the transaction. A formal loan agreement, while optional, is highly recommended for stronger evidence.

Consequences of Non-Compliance:

If these conditions are not met, the loan amount can be considered as income and taxed under “Income from Other Sources.” This means the amount will be added to your taxable income and subjected to your applicable tax slab rate. This can create a double burden, as you will be paying back the loan and paying taxes on it.

Legal Reference:

These conditions are based on Section 39 of the Income Tax Ordinance, which defines “Income from Other Sources.” This section states that any amount received as a loan, advance, deposit, or gift from a person not a banking company or financial institution can be treated as income if the specified conditions are not met. Income Tax Rules further elaborate on the required evidence for each income head, including loans.

Reporting Loans in IRIS (Wealth Statement):

Here’s how to correctly report loans in your wealth statement within the IRIS portal:

1. Access Wealth Statement: Log into IRIS and navigate to the “Wealth Statement” section.
2. Liabilities Section: In the liabilities section, add a new entry for the loan.
3. Loan Details: Provide details about the lender, including their name, CNIC/NTN, and relationship to you. Specify the nature of the loan and the loan amount.
4. Balance Adjustment: In subsequent years, only adjust the outstanding loan balance. Do not show loan repayments as outflows in the reconciliation statement. The reduction in the loan amount should automatically reflect as a corresponding adjustment to your bank balance or other assets. This prevents double counting.
5. Markup/Interest Payments: If you are paying markup or interest on the loan (outside of a formal banking arrangement), report these payments separately under “Personal Expenses” in the “Profit on Debt” category. Do not include principal repayments here.

Common Mistake to Avoid:

A common mistake is showing the full loan amount in the first year and then showing repayments as outflows in subsequent years. This is incorrect. The loan balance should be adjusted directly, as this will automatically reconcile with your assets.

In Summary:

Adhering to the FBR’s conditions for loans from friends and relatives is crucial to avoid tax complications. Proper documentation and correct reporting in the IRIS system are essential. If you are paying markup/interest on the loan, ensure it is reported separately as an expense. Failing to comply with these regulations can result in the loan being treated as income and subjected to taxation. It is always advisable to consult with a tax advisor for personalized guidance.