Prepayment charges paid for early closure of loan, whether to be allowed as deduction under the Incometax Act, 1961 or not? This question has arisen many times, however the Mumbai Bench of Income- tax Appellate Tribunal has finally given an affirmative answer on this issue in the case of Windermere Properties Pvt. Ltd. v. DCIT.1

Brief Facts of the case

In the present case, a loan was taken by the taxpayer for acquisition of property from the HDFC Bank. In the assessment year 2006-07, the taxpayer repaid the entire loan amount. While calculating the ‘Income from House Property’, the prepayment charges were claimed as deduction. However, during the assessment, deduction claimed by the taxpayer with respect to the prepayment charges was disallowed as deduction, according to the assessing officer, such charges do not qualify as a deduction and only the interest paid on the loan should be allowed for deduction.

Issue

Whether the prepayment charges for foreclosure of loan is deductible under the head Income from House Property?

Observations of the Tribunal:

  1. The Tribunal deliberated in detail the definition of interest as contained in Section 2(28A) of the Income Tax Act of 1961, which is stated as follows:
    "interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized.
    According to the above definition of ‘interest’, it can be interpreted that not only the any sum of money paid as interest is eligible for deduction under the said section, but also any other amount/sum of money paid in relation to such debt will also qualify for deduction under this section.
  2. The Tribunal observed that there was a direct link between prepayment of charges and loan availed for acquisition of property. The loan was availed by the taxpayer for acquiring a property and gradually such loan was repaid. Due to the receipt of prepayment charges, bank accepted early payment of loan. With such early payment of loan, taxpayer managed to remove the interest liability in respect of loan, which would have otherwise continued until the final payment of loan. Therefore there was direct correlation between the prepayment charges and the loan availed for acquisition of property and hence according to the tribunal, prepayment charges were to be allowed as a deduction under the head Income from House Property.

Conclusion

The above decision of the Tribunal is a welcome step and has been highly appreciated. Taking loan for acquiring a property is as it is a burden on general working class, by giving the term ‘interest’ such a wide interpretation, Tribunal has given some amount of relief to taxpayers. Taxpayers are usually required to pay substantial prepayment charges at the time of earlier payment of loan. By allowing to claim such prepayment charges as deduction while calculating Income from House Property would help in saving some amount of taxes.