For an Individual tax payer, Income Tax Act provides for deduction of interest paid on two types of loans – Home Loan and Education Loan. Section 80E of the Income Tax Act provides for deduction of interest paid on Education or Study loan taken for higher education (See the appendix for full text of Section 80E).
Note that the Income Tax benefit available for Education Loan under Section 80E is separate and distinct from the tax benefits available under section 80C. To know more about section 80C deductions, please read “Saving Income Tax through Smart Tax Planning – Guide to Section 80C Deductions”.
Following are the salient features of deduction on interest on Education Loan under Section 80E:
Deduction can be claimed only by Individuals
HUF and other assessee cannot claim Section 80E deduction. Moreover deduction can be claimed by an individual only if the loan has been taken in his name. Thus no deduction is available to an Individual if the loan is taken by any relative, say father, brother or spouse. In this case deduction will be available to the person who has taken the loan, provided that the Individual who is going for higher education is either a spouse or children of the Individual taking the Education Loan (more on this point below).
Loan from Banks
Education Loan should have been taken from a Bank in India (including Indian branches of foreign banks). Loans from notified financial institutions (currently only HDFC is notified) and approved charitable institution are also eligible for Section 80E deduction. No deduction would be available if the loan is taken from a Bank outside India. For example if you take Education Loan from Bank of America, New York branch for MBA study in Harvard (or in any institution in India for that matter) – no deduction would be available under Section 80E. However if you take a loan from Citibank, New Delhi branch for MBA education in IIM Ahmedabad, deduction would be available under Section 80E. No deduction under Section 80E would be available if the Education Loan taken from employer, family or friends.
Loan should be taken for Higher Education
Higher education means full-time studies for:
- Graduate or Post-graduate course in Engineering, Medicine, or Management, or
- Post-graduate course in Applied sciences or Pure sciences including Mathematics and Statistics.
Note tax benefit is not available for part-time courses. There is no condition that higher education should be done in India. Thus deduction is available even when the loan is taken for full-time higher education in the above areas outside India. The loan should be for pursuing higher studies means its includes loan taken not only for tuition or college fees only but other incidental expenses for pursuing such studies like hostel charges, transport charges, etc.
Higher education of Self or Relative
Loan should have been taken for full-time higher education of self or relative. Relative is defined to mean the spouse and children of the individual. Thus Education Loan taken for the higher education of brother or sister or father would not be eligible for deduction under Section 80E. Note prior to 1st April 2008, deduction was permissible only for the purpose of education of Self. Education Loan taken for the higher education of Spouse or Children has been added to the purview of Section 80E with effect from Assessment Year 2009-10 pertaining to Previous Year 2008-09. If an individual takes Education Loan for higher education of spouse or children, the tax benefit in form of Section 80E deduction is available to the individual only – not spouse or the children.
Repayment from Taxable Income
The repayment should be out of income chargeable to income tax, meaning if repayment is made from income exempted from income tax than deduction will not available. If repayment is done from another Loan or Gift, then also deduction is not available.
Deduction only for Interest
There is no deduction allowed under Section 80E for principal repayment of Education Loan. Note prior to 1st April 2006, both interest and principal repayment were eligible for deduction (but with an overall limit of Rs. 40,000 per annum). Currently Section 80E deduction is available only for the interest payment. (In order to calculate Principal and Interest component of Education Loan repayment, please download excel based calculator – Loan Amortisation Schedule)
No ceiling on the amount of deduction
There is no ceiling for deduction under Section 80E. Note prior to 1st April 2006, there was a ceiling of Rs. 40,000 for deduction under Section 80E. Currently the entire amount of interest paid in the year is eligible for deduction.
Deduction for Eight years
Deduction under Section 80E is available for 8 years or until the loan is repaid fully, whichever is earlier. First year starts from the year in which interest payment starts. Thus if the loan repayment stretches beyond 8 years, no benefit is available from 9th year onwards. Note it is not compulsory to complete the higher education before deductions can be claimed under Section 80E.
“SmartPaisa” Tax Planning Tips
Should you avail Education Loan if you have surplus funds available? This is interesting consideration and the answer would depend on how the surplus funds are invested. As long as the tax adjusted return from surplus funds is greater than the tax adjusted cost of the loan, it is better to avail Education Loan. What do I mean? Okay, let me explain by way of an example.
Suppose you need Rs. 100,000 for higher education and have two options to finance the same. You can avail Education Loan at 12% p.a. or you can are utilize your fixed deposit which is earning 9% p.a. Assuming you fall in the highest tax bracket (see the Income tax Rates) effective tax rate including surcharge and education cess is 33.99%. Since the interest on Education Loan is deductible under Section 80E and you save tax on the deduction, tax adjusted cost of Education Loan is 12% * (1 – 33.99%) = 7.92%. As long as you can generate tax adjusted return greater than 7.92%, it is advisable to go for Education Loan. In this example Fixed deposit interest is taxed at 33.99% and the tax adjusted return is 9% * (1 – 33.99%) = 5.94%. Thus if you intend to make a normal fixed deposit with the surplus funds, then taking Education Loan is not advisable since tax adjusted cost of 7.92% is greater than tax adjusted return of 5.94%. However if we assume that you make a 5-year Tax Saving fixed deposit under Section 80C (or for that matter any other investment allowed under Section 80C), then there is an additional deduction of Rs. 100,000 from the taxable income which means a tax savings of Rs 33,990. Thus to calculate effective return from the surplus funds, we have to consider tax adjusted interest income from fixed deposit plus the tax savings on the investment under Section 80C. After tax interest income is Rs 9,000 * (1 – 33.99%) = Rs 5,941. Tax saving under Section 80C is Rs. 33,990. Thus total return = Rs. 39,931, which translates to effective tax adjusted return from the surplus funds of 39.93%
However if you read carefully, there is one flaw in the argument above. The above logic is valid only if the individual would not be able to make Section 80C investment, if the Rs. 100,000 surplus funds are utilized for higher education. But if you have enough surplus funds or income to make the Section 80C investment, regardless of how you finance higher education, then it would logically incorrect to consider the tax benefit of Section 80C investment while evaluating whether or not to avail Education Loan. In such a scenario, where Section 80C investment has already been made, we should compare only the after tax return from surplus funds with the tax adjusted cost of the loan. One option could be to invest the surplus in such a way that the returns are tax free. For example if we assume that the Rs. 100,000 is invested in Debt Mutual Fund or Liquid Mutual Fund with Dividend Reinvestment mode, returns would be tax free. If these investments are expected to deliver returns greater than tax adjusted cost of the Education Loan (i.e. 7.82% in our example), it is still advisable to avail Education Loan.
Start interest payment only after you start earning. While Principal repayment is typically always deferred till completion of Education, most of the banks provide option to either pay interest starting immediately from disbursement or defer interest payment also till completion of Education. Logic is since the individual is not expected to have any income source prior to completion of education, moratorium is provided for both principal and interest till few months after completion of higher education. From tax planning perspective, it is recommended to defer both principal and interest payment till you start earning. The 8 year clock for claiming deduction under Section 80E starts ticking from the year in which interest payment starts, and not from the year in which education is completed. If you start making interest payment during the education period, in the initial years when your education is getting completed, you might not have any taxable income to claim Section 80E deduction. Note that interest on Education Loan paid in a particular year can be claimed as a deduction only that year, not later. Thus to maximize tax savings on deduction under Section 80E, it is always better to go for option to defer interest payment till completion of education.
Take loan in your name for your spouse or children’s education and start paying interest immediately. This suggestion is exactly opposite of what I told you just in the last point. But note the difference. In the first case you have taken loan for your own Education. Thus you are not expected to have taxable income till you complete your education. However in this example we are talking about scenario where you have availed Education Loan for the higher education of your spouse or children. Thus better to start paying interest immediately and start availing deduction immediately since it will reduce your tax liability immediately. There is no sense in delaying the deduction benefit if you are in tax paying bracket.
Take Education Loan for maximum possible amount. Education Loan is permissible for pursuing higher studies, means its includes loan can be taken not only for tuition or college fees only but other incidental expenses for pursuing such studies like hostel charges, transport charges, etc. Higher loan amount would mean higher interest amount which would be deductible from taxable income under Section 80E of the Income Tax Act. Remember, there is no upper limit on the amount of deduction allowed for interest payment on Education Loan under Section 80E.
Take the Loan from a Bank in India – Not from Family, Friend or Employer. Deduction under Section 80E is available only when the Education Loan is availed from a Bank in India (Loan from approved charitable institution also allowed). So do not take a loan from your family, friend or employer, as the interest paid on such loan would not qualify for Section 80E deduction.
Repay the Education Loan in 8 years. If possible, structure a ballooning repayment structure. Interest deduction under Section 80E is allowed over 8 years, beginning from the year in which interest payment starts. Thus repaying the loan in less than 8 years would mean you will forgo possible deduction from taxable income. A ballooning structure, where higher principal repayment happens in later years would ensure more interest payment and hence deduction. However, it is doubtful if the bank providing the loan would agree to a ballooning structure, since the average maturity of the loan under such a structure would be higher than a normal amortising loan for same tenor, which will make the loan more risky from debt-servicing perspective. However if an option to structure a ballooning repayment structure is available, it would be advisable to go for the same.
Appendix: Section 80E of the Income Tax Act
Deduction in respect of interest on loan taken for higher education.
(1) In computing the total income of an assessee, being an individual, there shall be deducted, in accordance with and subject to the provisions of this section, any amount paid by him in the previous year, out of his income chargeable to tax, by way of interest on loan taken by him from any financial institution or any approved charitable institution for the purpose of pursuing his higher education or for the purpose of higher education of his relative.
(2) The deduction specified in sub-section (1) shall be allowed in computing the total income in respect of the initial assessment year and seven assessment years immediately succeeding the initial assessment year or until the interest referred to in sub-section (1) is paid by the assessee in full, whichever is earlier.
(3) For the purposes of this section,
(a) approved charitable institution means an institution specified in, or, as the case may be, an institution established for charitable purposes and approved by the prescribed authority under clause (23C) of section 10 or an institution referred to in clause (a) of sub-section (2) of section 80G;
(b) financial institution means a banking company to which the Banking Regulation Act, 1949 (10 of 1949) applies (including any bank or banking institution referred to in section 51 of that Act); or any other financial institution which the Central Government may, by notification in the Official Gazette, specify in this behalf;
(c) higher education means full-time studies for any graduate or post-graduate course in engineering, medicine, management or for post-graduate course in applied sciences or pure sciences including mathematics and statistics;
(d) initial assessment year means the assessment year relevant to the previous year, in which the assessee starts paying the interest on the loan.
(e) relative, in relation to an individual, means the spouse and children of that individual.