Does loan settlement affect Income Tax?

Summary

Loan settlement happens when the borrower is unable to repay the entire loan and the bank takes a lesser amount and closes the loan. In this process, some part of the loan is forgiven, which is called Forgiven Amount. Now the question arises whether Income Tax is levied on this forgiven amount?

First of all, it is important to understand that the decision of tax applicability depends on the purpose for which the loan was taken. For example, if some part of the personal loan or credit card is forgiven, then this amount can be considered as taxable income under Income Tax. Conversely, should the loan be for business, the forgiven sum is recorded as company income and is subject to taxes.

Apart from this, the Income Tax Act’s Section 28(iv) makes it abundantly evident that any forgiven amount, which is obtained as a benefit—must be taxed. Tax is not applied, but, in some unique situations as government agricultural loan waivers or bankruptcy cases.

Introduction

Taking a loan has become a very common thing in today’s time. Whether it is to buy a house, a car, money for children’s education, or to expand the business, different types of loans are available for every need. But when you are unable to pay the EMI on time, the same loan becomes a burden. Many times, people reach a situation where they are unable to repay the entire loan. In such a situation, the option of loan settlement from the bank or financial institution is adopted.

Loan settlement means that the borrower and the bank waive off some amount of the loan by mutual consent, and the loan is closed by paying some fixed amount. This is a kind of agreement, where the entire loan is not repaid, but the loan account is closed by paying a certain amount.

Now the question arises that when the bank waives off some loan, is Income Tax levied on that waived amount? Does this increase your tax liability? Is this amount considered as income? And does it have to be considered as forgiven amount and tax has to be paid?

This is where the real confusion begins. Many people believe that there is relief after settlement, but the truth is that the Income Tax rules keep an eye on it. Especially if you have taken a personal loan or credit card loan, and a part of it has been forgiven, then the tax department tries to find out whether that forgiven amount is included in your income or not.

What is Loan Settlement?

It is a financial process in which the bank or financial institution allows the loan taker to settle the loan by paying a lesser amount instead of the entire outstanding loan amount. This facility is for those who are unable to repay their loans on time and are continuously defaulting.

Under a settlement, the bank can agree on a lump sum amount, which closes the loan. However, it is important to note that settling the loan can affect your CIBIL score, making it difficult for you to get a loan in the future. Therefore, it should be adopted only as a last option.

What is the difference between a Loan Settlement and a Credit Card Loan Settlement?

Although both Loan Settlement and Credit Card Loan Settlement aim to provide relief to the borrower, there are some important differences between them.

Points of Difference	Loan Settlement	Credit Card Loan Settlement
Type	Settlement of any type of loan (personal, home, car, education, etc.)	Settlement of Credit Card dues only
Settlement Process	The bank fixes a lump sum amount, on payment of which the loan gets settled.	The credit card company settles the amount at a fixed rate.
Impact on CIBIL score	CIBIL score may drop by 50-100 points, and it may become difficult to get a loan in the future	There is a huge impact on the CIBIL score, and it may be difficult to get a new credit card.
Possibility of getting a loan in the future	You may face problems in getting a home loan, a car loan, or any other loan.	Credit card companies may refuse to issue the card.

What documents are required for a Loan Settlement?

The following documents are required:

• Aadhar Card, PAN Card, Passport, or Driving License, etc.

• Salary slips, income tax returns, bank statements, etc.

• Loan Settlement letter, loan details, payment receipts, etc.

• Investment documents, property documents, insurance policies, etc.

How do I apply for a Loan Settlement online?

If you want to apply it online, then follow the easy steps given below:

Visit the bank’s website or app.

• Open the official website or mobile app of your loan provider or bank.

• Sign up if you already have an account, then log in. Otherwise, create a new account.

Check the customer support section.

• Go to the ‘Customer Support’ or ‘Contact Us’ section on the website or app.
• Here, you can find the option related to “Loan Settlement“, such as:
• Filing a loan-related complaint.
• Request form for loan settlement.

Fill out the request form for the settlement.

• Select the “Loan Settlement Request” option.
• Fill in the required details, such as:
• Your name
• Loan account number
• Email ID and mobile number
• Reason (why you want to settle, such as financial problems or reduction in income).

Upload the required documents.

• Upload documents that show your current financial situation, such as:
• Income certificate or salary slip
• Bank statement
• Any other proof that explains your problem?
• Upload all the documents by scanning them in the correct format (PDF or JPEG).

Submit and wait for the bank’s response.

• Once you have submitted the form, the bank will verify your request.

• The bank will most likely contact you within 7-10 working days. They will notify you of the settlement through email, call, or message.

Read the bank’s offer.

• The bank will make an offer to waive some portion of your pending amount. Carefully read it.

• If you accept the offer, go ahead. Otherwise, bargain further.

Make payment

• Pay the decided settlement amount from the bank in online payment mode.

• The bank will provide a payment confirmation and close your loan account.

How much impact does a Loan Settlement have on your CIBIL score?

Loan Settlement has a direct and negative impact on your CIBIL score. When a person takes a loan from a bank or NBFC and is unable to repay the entire amount due to some reason, the bank gives him a chance to make a settlement, which is called a Loan Settlement.

However, there is a huge difference between a Loan Settlement and a Loan Closure. If you close your loan by repaying its full amount, it is recorded as “Closed” in your credit report, which improves your CIBIL score. But if you have some amount of the loan waived off under an agreement with the bank, it is reported as “Settled”, which can harm your credit score.

What are the effects of a Loan Settlement on your CIBIL score?

• When a bank or NBFC reports to CIBIL that your loan is “settled”, your score drops immediately. The amount of drop depends on how good your score was earlier.

• Banks and financial institutions put customers who have settled their loans in the “high-risk” category. This means that in the future, if you try to take any type of loan (personal, home, car, or education), your application may be rejected.

• If you have settled a loan, it may be difficult to get a credit card from any bank in the future. Banks look at your credit history, and if they see a “settled” status, they may refuse to give you a credit card.

• Even if a bank decides to give you a loan, you may get the loan at a very high interest rate. This is because banks consider you a risky customer and charge a higher interest rate to protect their money.

• Loan settlement information remains in your CIBIL report for at least 7 years. This means that even if you improve your financial behavior later, your settlement record will continue to be visible to banks and may affect your creditworthiness.

What are the ways to improve your CIBIL score after a loan settlement?

If you have settled the loan and now want to improve your CIBIL score, then you can take the steps given below:

• Pay all loan and credit card bills in full on time.

• If possible, try to change the “Settled” status to “Closed” by contacting the bank.

• Use credit cards limitedly and make full payments on time.

• Take a small loan and repay it regularly to build a new good credit history.

• Check the CIBIL report regularly and request that CIBIL rectify any mistakes.

How long does it take for a Loan Settlement to be processed?

The time taken for the settlement process also depends on various factors, such as the policies of your bank or lender, the outstanding amount, and the communication between the two of you. Usually, this process can take from 1 to 3 months.

The first action in the process of settlement is to approach the bank, where you tell your problem and payment status to the bank. Then, the bank proposes a settlement offer according to your situation. In case you agree with that proposal, you need to pay the amount to the bank within the agreed time. The bank indicates the loan as settled, and this would take some time.

The longer this entire process continues, the more it can impact your CIBIL score, so it is preferable to resolve the issue sooner.

How to get NOC after loan settlement?

Let us know in simple language how you can get NOC after loan settlement.

1. First of all – Get confirmation of settlement

First of all, whenever you settle the loan, take a written settlement letter from the bank or financial institution on it. This letter is proof that you have paid the agreed amount and the bank has accepted it.

2. After this, Apply for NOC

After receiving the settlement letter, the next step is to ask for NOC from the bank. For this, you can write a formal letter or email to the bank in which you request that it issue a NOC.

3. Also – Attach all documents

When you send the application, do not forget to attach the following documents:

• Copy of the settlement letter
• Payment receipt or transaction details
• Your valid ID proof
• Loan account number
• Contact information

4. Then, follow up with the bank

Sometimes the bank may delay sending the NOC. In such a case, you should follow up by contacting the bank within 7-10 days. You can check the status through a phone call, email, or by visiting the branch.

5. Once you get the NOC, check it carefully

As soon as you get the NOC, check it carefully. Make sure that the following information is correct in it:

• Your name and loan account number
• Confirmation of payment
• Clear mention of “No Dues” or “No Objection”
• Bank seal and authorized signature
• If there is any mistake, contact the bank immediately and get it corrected.

What are the advantages and disadvantages of Loan Settlements?

It has the following advantages and disadvantages:

Advantages (Pros)

• Loan Settlement improves the financial condition of the borrower.

• By doing a Loan Settlement, you can manage your income and costs better and avoid a financial crisis in the future.

• The heavy burden of debt often causes mental stress. With Loan Settlement, the borrower gets relief from this stress, and he can find mental peace in his life.

• Through Loan Settlement, the borrower gets a chance to get part of their debt waived off.

• This helps to improve his financial condition and gives him relief from a heavy financial burden.

• Although a Loan Settlement can affect the borrower’s credit score, by following the agreement on time and properly, he can gradually improve his credit score.

Disadvantages (Cons)

• In the future, the borrower may have difficulty getting loans from these institutions.

• Through Loan Settlement, the entire loan of the borrower is not waived off. He still has to pay some amount, which can affect his financial condition.

• During a Loan Settlement, the agreement between the bank and the borrower has many conditions. The borrower is required to follow these conditions, which can limit their freedom.

• After a Loan Settlement, the borrower’s credit score may be affected.

• Loan Settlements may create difficulties in taking new loans or obtaining credit cards in the future.

• Due to a Loan Settlement, the borrower’s relationship with the bank and other financial institutions may deteriorate.

Is Loan Settlement the right option?

Loan Settlement is an option that comes up when a borrower is unable to repay the loan EMI. In such a situation, the bank or financial institution gives the customer an opportunity to settle the loan by paying a fixed amount, that is, the remaining amount is waived off. This option may sound easy, but there are many important things behind it, on which a decision should be taken after thinking carefully.

When can Loan Settlement prove to be the right option?

1. In a serious financial crisis:

If you have lost your job, have a serious illness or a situation has come where your income has completely stopped, then Loan Settlement can prove to be an emergency solution.

2. When there is no other option left:

If you have tried other measures like loan restructuring, relief in EMI or extension of payment deadline and still it is not possible to repay the loan, then this option can be adopted.

But why is it not always the right option?

1. Bad impact on CIBIL score:

After doing a loan settlement, “Settled” status is written in the credit report, which indicates that you have not repaid the entire loan. This can create problems in getting a loan or a credit card in the future.

2. Loan rejection in the future:

Banks may hesitate to give you a loan next time because they will not trust that you will be able to make the full payment.

3. There can also be legal risk:

In some cases, banks can take legal action even after settlement, especially when the agreement is not done properly.

What do experts say?

Financial advisors say that loan settlement should be seen as a last resort. If possible, talk to your bank first, get a new payment plan, or take some time off. Settle only when you have no other option and the situation is really serious.

Does loan settlement have any impact on income tax?

Let us understand this in detail and in simple language.

Is this forgiven amount taxable?

Yes, in many cases, this forgiven amount can be taxable. This is determined based on:

For what purpose the loan was taken:

• Personal loan/credit card loan: If you took a loan for personal expenses and a part of it is forgiven, then it can be considered taxable under “Income from Other Sources”.

• Business loan: If the loan was taken for business and a part of it is forgiven, then it is generally considered as business income, and may be taxed.

Who gives a loan waiver?

If a bank or financial institution gives a waiver, and the waiver is more than ₹10,000, then it may be taxable under Section 56(2) and Section 28(iv).

What does Section 28(iv) say?

Section 28(iv) of the Income Tax Act says that if a business gets any benefit in any form other than cash, then that will also come under the purview of tax. That is, if the loan is waived, then it can be counted as business profit.

Exceptions – In which cases is there no tax?

In some cases, loan settlement is not taxable, such as:

• The loan is not taken as a gift: If the loan is not taken as a gift, then the chances of tax being levied are reduced.

• Insolvency cases: If the loan is waived by the court, then there is no tax.

• Agricultural Loan Waiver: If the agricultural loan of a farmer is waived off, then it is tax free.

Is it necessary to show it in Form 26AS and Income Tax Return?

If the bank has deducted Form 16A or TDS after loan settlement, then its entry can be seen in Form 26AS. In such a situation, it becomes necessary to show it in the Income Tax Return (ITR).

What are the new RBI rules for Loan and Credit Card Settlement?

Let us know in detail what the new RBI rules are and why they are important for you:

1. Giving settlement offers will now be under a policy

RBI has directed that banks and NBFCs (Non-Banking Financial Companies) can now give settlement offers or waiver offers only under their internal policies. This means that no settlement or discount can be given without a written policy.

2. Board-approved policy is necessary

The bank will have to make a correct and transparent Settlement and Write-Off Policy, which is approved by its board. This policy should also state in which cases settlement will be given and in which cases it will not.

3. It is mandatory to give complete information to the customer

Before the settlement or writ of right process starts, it is necessary to give complete information to the customer in writing:

• Reason for settlement
• Outstanding amount
• Impact on CIBIL score after settlement
• Terms of settlement

4. Transparency in CIBIL reporting

If a customer has settled a loan or credit card, then the bank has to report this to the credit bureau (like CIBIL) correctly.

Example: If an account has been settled, it has to be shown as “Settled”, not “Closed” or “Paid”.

5. Guidelines for recovery agents

RBI has also said that before sending recovery agents, the customer should be given complete information. Also, there should be a complete record of the identity, time, date etc. of the agents.

6. Proper approval of the settlement or write-off is necessary

Any settlement or write-off will be valid only if:

• It is as per the bank’s policy.
• There is proper documentation for IT.
• All the rules related to it have been followed.

How will the customers benefit from these new rules?

Transparency will stop the bank’s arbitrariness will be stopped.

Correct information will go into the IL report.

Security of borrowers will be ensured.

It will be convenient to take the loan in the future.

Conclusion

Finally, when we carefully understand the relationship between loan settlement and income tax, it becomes clear that this topic is as complicated as it looks simple. First of all, it is important to know that loan settlement does not just mean that the bank has given you relief and the matter is over. After this, there are many economic and tax-related implications, which people often do not pay attention to.

Also, when the bank partially waives off a person’s loan, the waived amount may be considered as “income” by the tax department, especially if the amount is large. In this case, if you have taken a personal loan or had credit card dues and it is waived off, then tax may be due on it. Similarly, if you have taken a loan for business and a part of it is waived off, then it can be counted as your business profit.

Also, we should not forget that not all loan settlements are taxable. For example, if this waiver is done under insolvency, court order, or a special scheme of the government– ​​such as waiving off agricultural loans of farmers, then in such cases, tax exemption is given. That is, in every situatio, it is not necessary that you have to pay tax on the waived amount.

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