Took a Business Loan for Your MSME? Tax Benefits You Can Claim for FY25-26 (AY26-27)

Summary: 

• Section 36(1)(iii) permits all businesses (proprietorships, firms, LLPs, companies, MSMEs, and non‑MSMEs) to deduct interest expenses on loans taken for business use.  

• Interest is fully deductible when the loan is used for day-to-day business needs, like working capital or expansion. 

• If the business loan is used to buy an asset, any interest paid before the asset is put to use must be “capitalised”.  

• Tax benefit on such capitalised interest is received later through depreciation u/s 32. 

• Loan processing fees and administrative charges are allowed as deductions under Section 37(1). 

• Business loans with low interest rates can be explored + applied directly on the airpay money mobile application.  

As per the revised MSME classification (applicable w.e.f 1st April 2025), businesses in India are divided into Micro, Small, and Medium enterprises based on two factors: 

• How much money the business has invested in machinery/equipment and 

• How much annual sales (turnover) it generates 

A business is called a “Micro enterprise” if its investment is up to ₹2.5 crore and its annual turnover is up to ₹10 crore. It becomes a “Small enterprise” when investment goes up to ₹25 crore and annual turnover is less than ₹100 crore. The migration to a ”Medium enterprise” happens when investment increases up to ₹125 crore and turnover up to ₹500 crore.  

Now, as per the Income Tax Act, 1961, any business loan secured by such MSMEs offers several tax benefits. 

Want to know them? 

Read this article until the end. 

Interest on Business Loans is Allowed as a Tax Deduction u/s 36(1)(iii) 

Section 36(1)(iii) of the Income Tax Act, 1961 allows an MSME to claim a deduction for interest paid on money borrowed for business purposes. Let’s understand how this happens: allows an MSME to claim a deduction for interest paid on money borrowed for business purposes. Let’s understand how this happens: 

1. When Interest is Allowed as a Deduction 

Section 36(1)(iii) of the Income Tax Act, 1961 allows a deduction for interest paid or payable on capital borrowed for business or profession. The deduction is available to all assessees, including MSMEs, provided the borrowing is for business purposes.  

Interest is allowable even on an accrual basis. However, where the borrowed funds are used to acquire a capital asset, interest incurred up to the date the asset is first put to use must be capitalised and cannot be claimed as a revenue deduction. 

Realise that the law does not restrict the type of lender. The business loan may be taken from a bank, financial institution, NBFC, or even a private party. 

2. Restriction for Asset Purchase 

If the borrowed money is used to purchase or create a capital asset (such as machinery, equipment, or a building), then: 

• Interest paid from the date of borrowing until the date the asset is “first put to use” is not allowable as a revenue deduction under Section 36(1)(iii). 

• This interest must instead be added to the actual cost of the asset (capitalised). 

• Deduction (in the form of depreciation u/s 32) becomes available only after the asset is first put to use in the business. 

Note: Interest incurred after the asset is first put to use is deductible under Section 36(1)(iii) 

Processing Fees/Admin Charges are Allowed as a Deduction u/s 37(1) 

Section 37(1) of the Income Tax Act, 1961 is a “general/residual provision” that allows deduction of business expenses not specifically covered under Sections 30 to 36.  

When you take a startup business loan, you may have to incur loan processing fees and administrative charges. Such expenses can be claimed as a deduction under Section 37(1). 

Okay, but are there any conditions? 

Yes, such charges are allowable provided: 

• The loan is taken wholly for business or professional use and 

• The expense is not capital, personal, or prohibited by law in nature 

Note that the deduction is allowed in the year in which the expense is incurred or accrued, depending on the method of accounting followed. The expenditure must be incurred wholly and exclusively for the purposes of business or profession. 

Examples: How Can MSMEs Save Tax from Business Loans? 

M/s ABC Pvt. Ltd. is a registered MSME engaged in manufacturing activities. The entity takes a business loan from the airpay money app. Let’s see how the organisation can claim tax benefits under different scenarios: 

Case I: Business Loan Used for Purchase of an Asset 

M/s ABC Pvt. Ltd. borrows ₹5 lakhs to purchase new manufacturing machinery. 

• Loan sanction date: April 1, 2025 

• Machinery installed and put to use: October 1, 2025 

• Interest paid from April to September (before use): ₹1 lakh 

• Loan processing fee paid to bank: ₹3,000 

Now, if we talk about the tax treatment, interest paid (of ₹1 lakh) during the period when the machinery was not yet operational (April to September) is capitalised and added to the cost of the machinery. This increases the asset’s value for depreciation purposes. 

Once the machinery starts operating on October 1, 2025, depreciation becomes allowable u/s 32 on the total capitalised cost of ₹6 lakhs [purchase price (₹5 lakhs) + capitalised interest (₹1 lakh)].  

If the depreciation rate is 10%, the allowed deduction (as depreciation) for the FY 25-26 would be: 

• Depreciation for FY 2025-26: ₹30,000 (₹6,00,000 x 10% x 612)

Additionally, the processing fees of ₹3,000 are treated as a revenue expense and allowed as a deduction of u/s 37(1). Courts generally classify this as cost of raising finance, not cost of asset. Also, note that interest incurred from October 1, 2025, onwards will be allowable as a revenue deduction under Section 36(1)(iii). 

Case II: Business Loan Used to Meet Working Capital Requirements 

M/s ABC Pvt. Ltd. borrows ₹3 lakhs as working capital to purchase raw materials, pay suppliers, and manage daily business expenses. During the year: 

• Interest paid on loan: ₹50,000 and 

• Administrative charges paid to the bank: ₹2,000 

In this case, the interest on borrowed capital of ₹50,000 is allowed as a deduction u/s 36(1)(iii). No capitalisation is required because no asset is created. Additionally, administrative charges of ₹2,000 are allowed u/s 37(1).  

Conclusion 

So now you know that businesses (including MSMEs) can claim tax benefits from business loans in two ways. Interest on loans used for business activities is deductible under Section 36(1)(iii). When loans are used to acquire assets, interest paid before the asset is “put to use” is capitalised and later allowed through depreciation u/s 32.

In addition, loan processing fees and administrative charges remain deductible under Section 37(1) as business expenses. 

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