What Employers Need to Know About Salary Advances & Loans to Employees

It’s not uncommon to see that employees may need help financially and most companies help out by giving out salary advances or loans to their employees.
Hence, it’s important to consider a few things if you are inclined to give employees advances or even a loan.

Difference between salary advances & loans

Salary advances is paying an employee a portion of his salary in advance. For example – If an employee has a medical emergency and is in need for his salary of February in advance then the employer can pay him a portion of his salary beforehand.  The advances are recovered in installments and are usually interest-free.

A loan on the other hand is providing a loan at a concessional interest rate as opposed to market rate of interest. The loan could be of larger amount and could be of various types such as house loans, vehicle loans or education loans. Thus the difference between the concessional rate of interest and market rate can provide a huge relief to employees seeking a loan.

However, the difference between market rate (as charged by SBI) and the rate provided by the company loans is a Taxable perquisite in the hands of the employee.

How to create to a Loans & Advances policy

A written policy will go a long way in understanding eligibility criteria as well as setting up a uniform process for employees on how to apply.

This would also give your employees some advance notice on what to expect while applying.

A Written policy must have some parameters defining eligibility such as you can limit it to employees of have completed certain tenure. A written policy will also help you apply the policy in a non-discriminatory way across the board just as you would do for any other company perks.

Create a written agreement with an employee who gets an advance or loan

Written agreements ensure that everyone has the same understanding about what will happen. The loan is paid back through a payroll deduction and will be reflected in the Payslips of the employees.

How to calculate the Taxable value of an Interest-Free Loan

If a loan to an employee is provided at a rate less than SBI rate of 1^st of April of the previous year then the difference of interest will be charged as perquisite.

The steps to calculate the Perq (Perquisite) value is given below –

1.  Find out the Maximum outstanding monthly balance for each loan on the last day of every month.
2. Find out the rate of interest charged by SBI on that type of loan on the first day of relevant previous year
3. Calculate interest on amounts given in for the full financial year above @ rate of SBI as per point number 2 above and deduct interest recovered from the employee.
4. The balance will be taxable as perquisites in hand of employee.

Charging interest on loans

If you decide to loan money to an employee versus a payroll advance, you are allowed to charge them interest on the loan, as long as it is a reasonable amount.

The laws do state that the employer cannot profit from the transaction. Thus one must be careful about how much interest you charge.