A friendly loan is basically lending money to your friends or relatives for a personal reason like to help them in the time of financial difficulties.
A loan to a family member or a friend is usually an unsecured loan and the terms and conditions are basically undefined or indeterminate and demanding payback is often difficult. And if the loan goes bad, the relationship also sours. Moreover, such a loan is usually interest-free. This means you lose money.
There are two ways of doing this:
A Promissory note is a written promise to pay a debt. It is a financial instrument, in which one party promises in writing to pay a determinate sum of money to the other, either at a fixed, determinable future time or on demand of the payee subject to specific terms and conditions.
If you wish to keep it simple and only for the record, go for a promissory note. This instrument comes under Section 4 of the Negotiable Instruments Act, 1881, and has to be signed by the borrower.
A Loan Agreement (Loan Contract) acknowledges that there is a loan, specific promise to pay and also states that the lender has a right to recourse. An example can be a FORECLOSURE. If you want to have a right to recourse, then go for Loan Agreement instead of a Promissory Note.
A friendly loan is generally without any interest and there is no provision to charge any notional interest on the same. But if you charge interest rate then interest earned on loan has to be treated as “Income from other sources.” This income should be shown in your (lender) Income Tax Return.
If you borrow money from your friend/relative to construct a house, the repayments are not eligible for tax deductions. Tax deduction under Section 80c with respect to principal repayment is not allowed. But Tax benefit under Section 24 of the Income Tax Act can be claimed as Tax deduction with respect to Interest paid on loan. The main criteria is ‘the loan should not be for personal use.
Gifts from family members are not taxable, neither are the loans. But any gift above Rs 50,000 from a friend during a financial year is taxable. However, if it’s a loan (with or without interest), it becomes tax-free.