Introduction The interest deducted in advance from the principal in loan relationships is commonly referred to as "pre-deducted interest" in the community. The existence of "pre-deducted interest" is to help lenders recover interest in advance and reduce the risk of the loan by deducting interest from the principal when providing the loan. However, this practice results in the amount available to the borrower for direct use being essentially the amount after deducting the interest from the agreed principal. Nevertheless, the borrower is required to pay interest based on the agreed principal. This undoubtedly increases the burden on the borrower and harms the borrower's legitimate interests. To address this issue in practice, uphold the principle of fairness, and prevent lenders from determining unequal contract terms using their advantageous position, Article 670 of the Civil Code and Article 26 of the Supreme People's Court's Provisions on Several Issues Concerning the Application of Law in the Trial of Private Lending Cases (Second Amendment in 2020) have clearly provided a negative assessment of the act of collecting "pre-deducted interest" – the actual lent amount is recognized as the principal, and interest deducted in advance from the principal is rejected.

What are the forms of "pre-deducted interest"? The forms of "pre-deducted interest" can be broadly categorized into "typical pre-deducted interest" and "atypical pre-deducted interest."

(Typical Pre-deducted Interest) Typical pre-deducted interest involves deducting the interest directly from the loan amount before delivering the principal. For example, if a borrower borrows 1 million yuan from a lender, and according to the agreement, the borrower should pay 100,000 yuan in interest at the end of the term. However, the lender deducts this interest directly when providing the loan, giving the borrower only 900,000 yuan as a loan but expects the borrower to consider 1 million yuan as the loan principal and repay 1 million yuan as the principal at the end of the loan term. This example illustrates a "typical pre-deducted interest." According to the aforementioned legal provisions, after the loan term ends, the borrower can assert that they actually received a loan of only 900,000 yuan and should only repay the lender the 900,000 yuan as the principal and pay interest calculated based on the 900,000 yuan principal. Any excess interest paid can be offset against the loan principal or claimed for reimbursement.

(Atypical Pre-deducted Interest) To avoid the risk of directly collecting "pre-deducted interest," various variants of pre-deducted interest, referred to as "atypical pre-deducted interest," have emerged in practice. Common practices by lenders include:

Charging so-called service fees, inquiry fees, consultation fees, credit check fees, advisory fees, management fees, etc., without providing actual services, either in the lender's or a third party's name.

Demanding that the borrower pay interest on the same day or the day after receiving the loan.

Requiring the borrower to pay interest in cash after providing the loan through a transfer.

Asking the borrower to deposit a portion of the interest into a designated "security deposit" account.

Although these practices differ from the "typical pre-deducted interest" mentioned earlier, as they do not directly deduct the interest from the loan amount at the time of lending, they still deprive the borrower of the ability to fully use and manage the borrowed principal. This, in turn, undermines the borrower's right to the term interest on part of the loan principal. Considering the legislative intent and the nature of interest, these practices should be negatively assessed.

How is "pre-deducted interest" recognized in judicial practice? (Typical Pre-deducted Interest) Regarding "typical pre-deducted interest," its direct form is evident – by seizing the key point of "directly deducting interest at the time of lending," this can be determined. Further elaboration on this point is not necessary here.

(Atypical Pre-deducted Interest) Given the diverse and covert forms of "atypical pre-deducted interest," the author, based on practical case-handling experience and a study of relevant cases, provides a brief summary of some circumstances for recognizing "atypical pre-deducted interest" in judicial practice:

Time of interest collection Collecting interest on the day of or the day after the loan disbursement is generally recognized as "pre-deducted interest." For specific reference, see the judgment in Civil Judgment No. 467 of 2018 by the Supreme People's Court: "In this case, after Bank A, Anshan Branch, disbursed 250 million yuan to Company B on November 27, 2013, they collected 19.875 million yuan in interest the next day. The court believes that Bank A, Anshan Branch, collecting this 19.875 million yuan interest constitutes an atypical act of 'deducting interest from the principal,' restricting the financial conditions for Company B to use the principal to create economic benefits, resulting in unfairness to Company B. Therefore, this 19.875 million yuan should be recognized as 'pre-deducted interest' and deducted from the principal." If the interest is collected several days after the loan disbursement, it may not be considered "pre-deducted interest." For specific reference, see Civil Ruling No. 4895 of 2019 by the Supreme People's Court: "Li Xiaoqing acknowledges receiving 2.25 million yuan in interest, but the three interest payments were made after Li Xiaoqing provided the loan, not deducted at the time of providing the loan or paid on the day of providing the loan. Huang Xiaobo argues that the 2.25 million yuan he paid should not be counted towards the loan principal, which has no factual basis."

Reasonableness of collecting service fees, consultation fees, etc. When the entity collecting service fees, consultation fees, or similar charges cannot prove that they provided the corresponding services, the collection of such fees is deemed unreasonable. The so-called service fees, consultation fees, etc., are generally recognized as "pre-deducted interest." For specific reference, see Civil Judgment No. 1081 of 2019 by the Supreme People's Court: "In this case, if China Rongxin Trust cannot prove that they provided specific financial advisory services to Meiyuan Huasheng, it should be determined that they did not provide financial advisory services. The 21.07 million yuan financial advisory fees should be deemed as interest pre-collected under the guise of advisory fees and deducted when calculating the outstanding principal."

Relationship between the lender and the fee-collecting entity In cases where a third party outside the lender collects service fees, consultation fees, or similar charges without demonstrating the provision of corresponding services, and if this third party has an affiliated relationship with the lender, the so-called service fees, consultation fees, etc., are generally recognized as "pre-deducted interest." For specific reference, see Guiding Case No. 155 for Instructional Purposes: "Some small loan companies, as non-bank financial institutions, to evade regulation, utilize their advantageous position in lending operations, employing illegal means such as pre-deducting the loan principal and surreptitiously collecting high interest, thereby infringing on the legitimate rights and interests of borrowers and disrupting the financial market order. On the surface, these small loan companies establish affiliated companies and require borrowers to enter into consulting, intermediary, and other service contracts with these affiliated companies, collecting fees for consulting, management, service, advisory, and more. However, in reality, this is a pre-deduction of the loan principal and a covert collection of high interest."

Degree of restriction on the use of the security deposit Not all security deposits are recognized as "pre-deducted interest." If the borrower has not lost control over the security deposit and can still effectively use it, the security deposit generally will not be considered "pre-deducted interest." For specific reference, see Civil Judgment No. 467 of 2018 by the Supreme People's Court: "The court believes that although the 19.875 million yuan was deposited by Company B into the security deposit account and was indeed later used to pay 'interest,' according to the terms of the 'Security Deposit Agreement,' if Company B uses this security deposit within six months from the date of deposit, it will only lead to Bank A, Anshan Branch, calculating interest on the demand deposit. It can be seen that Company B still has control over this fund and has not affected its actual use. Therefore, this 1.9875 million yuan does not fall under 'pre-deducted interest' and should not be directly deducted from the loan principal. Instead, it should be first used to offset the loan interest, and the remaining amount can be used to offset the loan principal."

This article is a summary of the author's cognitive conclusions based on their own experiences in handling cases and should not be taken as legal advice for specific cases! Lawyers recommend providing relevant evidence when encountering similar disputes for case-specific consultations.

Legal provisions referenced in this article:

Article 670 of the Civil Code: "Interest on a loan may not be pre-deducted from the principal. If interest is pre-deducted from the principal, the actual amount lent shall be returned as the loan, and the interest shall be calculated accordingly."

Article 26 of the Supreme People's Court's Provisions on Several Issues Concerning the Application of Law in the Trial of Private Lending Cases (Second Amendment in 2020): "The loan amount stated in debt certificates, receipts, IOUs, and other debt vouchers is generally deemed as the principal. If interest is pre-deducted from the principal, the people's court shall determine the actual lent amount as the principal."