Salary Advances and Employee Loans: The New ₹2 Lakh Tax-Free Limit
Under the Income-tax Rules, 2026, interest-free or low-interest employer loans carry no perquisite tax if the total outstanding is ₹2 lakh or less, up from ₹20,000. Above that, the interest benefit at the SBI rate is taxed as salary. Recoveries from wages must keep total deductions within 50% of wages under the Code on Wages.
Small businesses lend money to employees all the time: a festival advance, school fees, a medical emergency. Until March 2026, any interest-free loan above ₹20,000 created a tax perquisite that payroll was supposed to calculate and almost nobody did. The limit is now ten times higher.
What changed
Under the Income-tax Rules, 2026, from 1 April 2026:
- ✓if the total outstanding of an employee's interest-free or low-interest loans is ₹2 lakh or less, there is no perquisite;
- ✓loans for treatment of specified illnesses remain exempt, except to the extent reimbursed by insurance.
The old limit was ₹20,000.
When a loan is taxable
If the outstanding balance exceeds ₹2 lakh, the employee is taxed on the interest benefit: the difference between the interest charged and the interest at the State Bank of India's rate for a similar loan, worked out on the monthly outstanding balance.
A worked example
A supervisor takes a ₹3 lakh interest-free loan for a family wedding, repayable over 12 months. The outstanding balance is above ₹2 lakh for the first four months. Payroll works out the interest benefit at the SBI rate on the balance for those months and adds it to taxable salary. Once the balance falls to ₹2 lakh or below, there is no perquisite.
Recovering the loan from salary
- ✓The Code on Wages allows deductions for advances and loans, but total deductions in a wage period must not exceed 50% of wages.
- ✓Put the repayment schedule in writing, signed by the employee.
- ✓On exit, recover the balance from the final settlement, within the same 50% cap on that period's wages. Agree how the rest will be repaid.
A simple loan policy
- Who can apply, and after how many months of service.
- Maximum amount, such as two months' gross salary.
- Repayment period and monthly instalment.
- Interest rate, if any.
- What happens on resignation or termination.
- Approval levels.
Frequently asked questions
Is a salary advance a loan?
An advance recovered from the next salary or two is usually treated as an advance of salary rather than a loan. Longer repayments should be treated as loans.
Do we deduct TDS on the perquisite?
Yes. The perquisite is part of salary, so include it when working out monthly TDS.
Can we charge interest to avoid the perquisite?
Yes. If you charge at least the SBI rate, there is no perquisite.
Sources
- ✓Tax-free loans from employers: how the rules changed, EMI Calculator
- ✓Draft Income-tax Rules 2026: employee perquisite valuation, TaxGuru
- ✓Taxability of concessional or interest-free loans, Income Tax Department
This is a summary, not tax advice. Confirm with your chartered accountant before you rely on it.
Written by
HR Manager, Airwix Technologies (Sleet)
Nihit Dobariya is the HR Manager at Airwix Technologies in Ahmedabad, where he runs HR and payroll for the team behind Sleet. He writes about payroll, PF and ESIC, professional tax, the labour codes and everyday HR practice for Indian employers, and checks each rule against the official notification before it is published.
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