Section 94B was
enacted by the Finance Act, 2017, with effect from 01.04.2018 in order to
mitigate the impact of interest expenditure claimed by business enterprises by
prescribing a cap @30% of EBITDA
(Earnings Before Interest, Taxes,
Depreciation, and Amortization). This refresher takes note of the thin
capitalization concept contained in the Income-tax Act vis a vis the Base
Erosion and Profit Shifting (BEPS) Action Plan 4.
Under the
initiative of the G-20 countries, the Organization for Economic Co-operation
and Development (OECD) in its Base Erosion and Profit Shifting (BEPS) project
had taken up the issue of base erosion and profit shifting by way of excess
interest deductions by the MNEs in Action plan 4. In view of the above, a new
Section 94B, was inserted by the Finance Act, 2017, w.e.f. 01.04.2018 which
provides that interest expenses claimed by a Company to its associated
enterprises shall be restricted to 30% of its earnings before interest, taxes,
depreciation and amortization (EBITDA) or interest paid or payable to
associated enterprise, whichever is less.
Limitation of Interest deduction in certain cases - Explanatory Notes to the Provisions of the Finance Act, 2017 issued vide Circular No. 02/2018 dated 15.02.2018
46.1 A company is typically financed
or capitalized through a mixture of debt and equity. The way a company is
capitalized often has a significant impact on the amount of profit it reports
for tax purposes as the tax legislations of countries typically allow a
deduction for interest paid or payable in arriving at the profit for tax
purposes while the dividend paid on equity contribution is not deductible.
Therefore, the higher the level of debt in a company, and thus higher the
amount of interest it pays, the lower will be its taxable profit. For this
reason, debt is often a more tax efficient method of finance than equity.
Multinational Enterprises (MNEs) are often able to structure their financing
arrangements to maximize these benefits. For this reason, tax administrations
of several countries have introduced rules that place a limit on the amount of interest
that can be deducted in computing a company’s profit for tax purposes. Such
rules are designed to counter cross-border shifting of profit through excessive
interest payments, and thus aim to protect a country’s tax base.
46.2 Under the initiative of the G-20
countries, OECD in its Base Erosion and Profit Shifting (BEPS) project had
taken up the issue of base erosion and profit shifting by way of excess
interest deductions by the MNEs in Action plan 4 and has recommended several
measures in its final report to address this issue.
46.3 In view of the above, a new
section 94B has been inserted in the Income-tax Act so as to provide that
interest expenses claimed by an entity to its associated enterprises shall be
restricted to 30% of its earnings before interest, taxes, depreciation and
amortization (EBITDA) or interest paid or payable to associated enterprise,
whichever is less.
46.4 The provisions of the section
94B of the Income-tax Act shall be applicable to an Indian company, or a
permanent establishment of a foreign company being the borrower who pays
interest in respect of any form of debt issued to a non-resident or to a
permanent establishment of a non-resident and who is an ‘associated enterprise’
of the borrower. Further, the debt shall be deemed to be treated as issued by
an associated enterprise where it provides an implicit or explicit guarantee to
the lender or deposits a corresponding and matching amount of funds with the
lender.
46.5 The provisions of the said
section allow for carry forward of disallowed interest expense to eight
assessment years immediately succeeding the assessment year for which the
disallowance was first made and also allow deduction against the income
computed under the head ‚Profits and gains of business or profession‛ to the
extent of maximum allowable interest expenditure.
46.6 In order to target only large
interest payments, the said section also provides for a threshold limit of
interest expenditure of one crore rupees exceeding which the provision would be
applicable.
46.7 Further, banks and insurance
business have also been excluded from the ambit of the said provisions keeping
in view of special nature of these businesses.
46.8 Applicability: This amendment
takes effect from 1st April, 2018 and will, accordingly, apply from assessment
year 2018-19 and subsequent years.
Section 94B provides that if an Indian company, or
a permanent establishment of a foreign company in India, being the borrower,
incurs any expenditure by way of interest or of similar nature exceeding rupees
1 crore, which is deductible in computing income chargeable under the head
‘Profits and gains of business or profession’ in respect of any debt issued by
a non-resident Associated Enterprises in respect of any debt issued as
mentioned in the following cases then excess interest shall be disallowed:
(i)
Debt
issued by Associated Enterprises or,
(ii)
Debt
issued by a lender which is not associated but an associated enterprise either
provides an implicit or explicit guarantee to such lender or deposits a
corresponding and matching amount of funds with the lender
The
‘excess interest' shall mean an amount of total interest paid or payable more
than 30% of EBITDA in the previous year, or interest paid/payable to AE for
that previous year, whichever is less.
Calculation of Interest
Interest shall
be calculated in the following manner:
Excess interest shall be disallowed whereas
excess interest shall mean lower of the followings:
(i)
Total interest
paid or payable in excess of thirty percent of EBITDA (earnings before
interest, taxes, depreciation and amortization) of the borrower in the previous
year or,
(ii)
Interest paid or
payable to associated enterprises for that previous year
It may be
pertinent to note that the objective of the provision to restrict the amount of
interest paid to Non–resident associated enterprises and therefore, a view can
be taken that the total interest means interest paid or payable to Non-Resident
Associated Enterprises. Total interest will not include interest paid or
payable to banks, financial institution, third party or any other resident
related entities etc.
It may
also be noted that the para 46.1 of the Circular No. 2/2018 dated 15.02.2018
issued by CBDT clearly clarifies that the provision of Section 94 B was brought
to counter cross-border shifting of profit through excessive interest payments,
and thus aim to protect a country’s tax base. Therefore, it is clear that the
total interest should include only total interest means interest paid or
payable to Non-Resident Associated Enterprises.
Section 94B imposes a cap on the deduction of interest expenses incurred on borrowings from Associated Enterprises. The provision seeks to prevent companies from over-leveraging on debt, especially from an Associated Entity to reduce the taxable income, promoting a healthier balance between the debt and equity in corporate financing.
Typically,
capital employed by a company to run its business consists of own and borrowed
capital. Own capital i.e. share capital and reserves, do not have interest
liability, whereas borrowed capital, whether long term or short term, requires
interest to be paid to external parties. Such interest cost, unless
capitalised, is debited to the profit and loss account, and generally, allowed
as a deduction under the domestic tax laws applicable to a company. If a
company is having very high borrowed capital as compared to own capital, it
shall incur high interest cost, and such capitalisation-mix is generally
referred to as 'thin capitalisation'. Thin capitalisation has a significant
impact on the profitability and the consequent taxability of the company. On
the other hand, if capital is financed by shareholders' funds, the return on
share capital is in the form of the dividend, and constitutes a below the line
item in the books, and is not deductible from the taxable income of the
company.
Section 94B – A brief background
§ The government observed that, non-resident associated
enterprises of Indian companies used debt/borrowings instead of equity
investment to fund operations in India.
§ This resulted in the indian companies enjoying excess
interest deduction while computing taxable income. This is referred to as thin
capitalisation
§ The government introduced Section 94B (Thin capitalisation
rules) to curb such companies from enjoying deduction of excess interest.
Applicability of Section 94B
The
provisions of Section 94B apply to:
§
Indian
companies or permanent establishments (PEs) of foreign companies in India.
§
Permanent
Establishment includes a fixed place of business through which the business of
the enterprise is wholly or partly carried on.
§
Entities
incurring interest expenses on loans or borrowings from Associated Enterprises.
Exceptions - Non applicability of
section 94B
Nothing
contained in sub-section (1) shall apply to an Indian company or a permanent
establishment of a foreign company which is engaged in the business of banking
or insurance or a Finance Company located in any International Financial
Services Centre or such class of non-banking financial companies as may be
notified by the Central Government in the Official Gazette in this behalf.
Objectives of Section 94B
In
line with the recommendations of OECD BEPS Action Plan 4, the Finance Act, 2017
introduced a new Section 94B in the Income Tax Act, to address the issue of
excess interest deductions by the MNCs.
Section
94B aims to achieve several key goals:
(i)
Curbing Profit Shifting
The
provision addresses practices where MNCs shift profits to low-tax jurisdictions
through excessive interest payments, protecting India's tax base.
(ii)
Ensuring a Balanced Capital Structure
By
limiting interest deductions, the section encourages businesses to maintain a
healthy balance between debt and equity, reducing financial risks.
(iii)
Promoting Fair Taxation
Section 94B aligns with global
best practices under the Organization for Economic Co-operation and Development
(OECD) in its Base Erosion and Profit Shifting (BEPS) Action Plan 4 - 'Limiting
base erosion involving interest deductions and other financial payments' which
focuses on preventing tax base erosion through excessive interest deductions.
Text of Section 94B
[1][94B. Limitation
on interest deduction in certain cases.
(1)
Notwithstanding anything contained in this Act, where an Indian company, or a
permanent establishment of a foreign company in India, being the borrower,
incurs any expenditure by way of interest or of similar nature exceeding one
crore rupees which is deductible in computing income chargeable under the head
"Profits and gains of business or profession" in respect of any debt
issued by a non-resident, being an associated enterprise of such borrower, the
interest shall not be deductible in computation of income under the said head
to the extent that it arises from excess interest, as specified in sub-section
(2) :
PROVIDED that where the debt is issued by a lender
which is not associated but an associated enterprise either provides an
implicit or explicit guarantee to such lender or deposits a corresponding and
matching amount of funds with the lender, such debt shall be deemed to have
been issued by an associated enterprise.
[2][ (1A)
Nothing contained in sub-section (1) shall apply to interest paid in respect of
a debt issued by a lender which is a permanent establishment in India of a
non-resident, being a person engaged in the business of banking.]
(2) For the purposes of sub-section (1), the excess interest shall mean an amount of total interest paid or payable in excess of thirty per cent of earnings before interest, taxes, depreciation and amortisation of the borrower in the previous year or interest paid or payable to associated enterprises for that previous year, whichever is less.
(3) Nothing contained in sub-section (1) shall apply
to an Indian company or a permanent establishment of a foreign company which is
engaged in the business of banking or insurance [3][or a
Finance Company located in any International Financial Services Centre,] [4][or such class of non-banking financial companies as may be notified by
the Central Government in the Official Gazette in this behalf].
(4) Where for any assessment year, the interest
expenditure is not wholly deducted against income under the head “Profits and
gains of business or profession”, so much of the interest expenditure as has
not been so deducted, shall be carried forward to the following assessment year
or assessment years, and it shall be allowed as a deduction against the profits
and gains, if any, of any business or profession carried on by it and
assessable for that assessment year to the extent of maximum allowable interest
expenditure in accordance with sub-section (2):
PROVIDED that no interest expenditure shall be
carried forward under this sub-section for more than eight assessment years
immediately succeeding the assessment year for which the excess interest
expenditure was first computed.
(5) For the purposes of this section, the
expressions—
(i) “associated
enterprise” shall have the meaning assigned to it in sub-section (1) and
sub-section (2) of section 92A;
(ii) “debt”
means any loan, financial instrument, finance lease, financial derivative, or
any arrangement that gives rise to interest, discounts or other finance charges
that are deductible in the computation of income chargeable under the head “Profits
and gains of business or profession”;
[5][(iia) “non-banking financial company” shall have the meaning assigned to
it in clause (vii) of the Explanation to clause (viia) of sub-section (1) of
section 36;]
(iii) “permanent
establishment” includes a fixed place of business through which the business of
the enterprise is wholly or partly carried on.]
[6][(iv) “Finance
Company” means a finance company as defined in clause (e) of sub-regulation (1)
of regulation 240b of the International Financial Services Centres Authority
(Finance Company) Regulations, 2021 made under the International Financial
Services Centres Authority Act, 2019 (50 of 2019) and which satisfies such
conditions and carries on such activities, as may be prescribed;
(v) “International
Financial Services Centre” shall have the meaning as assigned to it in clause
(q) of section 240c of the Special Economic Zones Act, 2005 (28 of 2005).]
KEY NOTE
1. Inserted
by the Finance Act, 2017, with effect from 01.04.2018.
2. Inserted
by the Finance Act, 2020, with effect from 01.04.2021.
3. Inserted
by the Finance (No. 2) Act, 2024, with effect from 01.04.2025.
4. Inserted
by the Finance Act, 2023, with effect from 01.04.2024.
5. Inserted
by the Finance Act, 2023, with effect from 01.04.2024.
6. Inserted
by the Finance (No. 2) Act, 2024, with effect from 01.04.2025:
Section 94B(1) says
Sub-section
(1) directs one to sub-section (2) for the purposes of quantifying the excess
interest. The excess interest shall be the lower of following two limbs:
Total
interest paid or payable in excess of 30% of earnings before interest, taxes,
depreciation and amortisation (EBITDA) [EBITDA Test] or
Interest
paid or payable to associated enterprises for that previous year [Actual
incurrence test]
NOTE
§
EBITDA test limits the ‘total interest’ to a fixed percentage
(30%) of the entity’s profits. Such profits are measured using EBITDA. Assuming
ascertaining EBITDA should not pose any challenges, the only component whose
interpretation requires clarity is ‘total interest’.
§
Actual incurrence test
The interest paid to associated
enterprises (including deemed associated enterprise) must be considered in this
test. In the absence of any qualifying words, the interest paid to all
associated enterprises must be considered, irrespective of their residence.
The computation under the two
tests is compared. The lower of the two constitutes ‘excess interest’ under
section 94B(2). This excess interest requires to be compared with the actual
payment of interest to non-resident associated enterprises.
Proviso to section 94B(1) says
The
proviso to section 94B(1) stipulates that debt issued by a lender which is not
an associated enterprise shall be deemed to be a debt issued by an associated
enterprise under specified circumstances.
Section 94B(1A) says
The
Finance Act, 2020 w.e.f 01.04.2021 inserted sub-section (1A) to section 94B
whereby the provisions of this section will not apply in respect of interest
paid for a debt issued by a lender which is a permanent establishment (PE) of a
non-resident and where such non-resident being a person engaged in the business
of banking.
Section 94B(2) says
Where the
interest expenditure incurred is more than the threshold limit of 30% of EBITDA
and the entire interest expenditure was thus not deductible against the income
under the head 'Profits and gains of business or profession', such amount of
interest not so deducted shall be carried forward to subsequent assessment year
or years for set off against the profits and gains, if any, of any business or
profession carried on by the borrower-assessee which is assessable for that
assessment year. However, for that year also the deduction is limited to 30% of
EBITDA being the maximum allowable interest expenditure specified in section
94B(2).
Section 94B(3) says
Section
94B(3) says that the interest limitation shall not apply to an Indian company
or a permanent establishment of a foreign company which is engaged in the
business of banking or insurance or a Finance Company located in any International
Financial Services Centre or such class of non-banking financial companies as
may be notified by the Central Government in the Official Gazette in this
behalf.
Section 94B(5) says
Section
94B(5) says associated enterprise shall have the meaning assigned to it in
section 92A(1) dealing with associated enterprise and section 92A(2) dealing
with deemed associated enterprise.
‘Debt’
means any loan, financial instrument, finance lease, financial derivative or
any arrangement that gives rise to interest, discount or other finance charges
which are deductible while computing the income chargeable under the head ‘Profits
and gains of business or profession’. The term 'permanent establishment'
includes a fixed place of business through which the business of the enterprise
is wholly or partly carried on. Thus, even if there is no fixed place of
business, the term PE is covered since the expression used is 'includes' and
would therefore span beyond what is given in the section.
Position prior to the Finance Act, 2017
Prior to
the amendment by the Finance Act, 2017, interest expenditure has been allowed
without any limit, if incurred for the purpose of business.
For
instance, in the case of DIT, International Taxation v. Besix Kier Dabhol[2012]
26 taxmann.com 169/210 Taxman 151 (Bom.), the taxpayer, a non-resident company
carried out certain construction project in India, and thus formed a
Permanent Establishment (PE) in India.
The
company had equity capital of Rs. 38.00 lacs and debt capital of Rs.9410 lacs.
Thus, debt equity ratio worked out is to 248:1. Assessee paid interest of Rs.
5.73 crores on the aforesaid borrowing. Assessing Officer disallowed the
interest expenditure which was upheld by the CIT(A).
During the
course of the proceedings before the Tribunal the revenue contended that the
borrowings on which the interest has been claimed as a deduction are in fact
capital of the assessee and brought only under the nomenclature of loan for tax
consideration. It was the case of the revenue before the Tribunal that debt
capital is required to be re-characterized as equity capital. However, the
Tribunal held that in India as the law stands there were no rules with regard
to thin capitalization so as to consider debt as an equity.
Consequently,
the interest payment on debt capital could not be disallowed. Subsequently, the
Bombay High Court upheld the Tribunal's order in the above case.
Lender and borrower for the purpose of section 94B
§ The lender should be a non-resident associated enterprise
of an Indian company or a permanent establishment of a foreign company.
§ The borrower should be an Indian company or a permanent
establishment of a foreign company.
Note: If the
debt is provided by any lender who is not an associated person, but if an
associated person, either
§ provides a guarantee to such lender on behalf of the
borrower (or)
§ deposits a corresponding amount with the lender
then such debt
shall be deemed to have been issued by an associated enterprise.
For eg. Assume,
B and C are associated enterprises,
Situation 1: A (third party)
gives loan to B – provisions of section 94B will not be applicable
Situation 2: A (third party)
gives loan to B, C gives a guarantee to A on behalf of B for the loan amount –
provisions of section 94B will be applicable.
Thin Capitalisation is used by the entities mainly due to the following reasons:
§
Leverage interest deductions: Interest on loans is typically tax-deductible,
reducing taxable profits by claiming it as an expense in P&L.
§
Shift profits to low-tax
Jurisdictions:
Multinational corporations (MNCs) often take loans through their associated
enterprises operating in low/Nil tax jurisdictions, minimising overall tax
liabilities due to charging the interest paid as an expense in the P&L on
the one hand and thereby not paying any tax in the hands of the recipient in
the country of residence of such recipient (Low tax Jurisdiction).
For
instance, imagine an Indian subsidiary borrowing extensively from its parent
company operating in a low-tax jurisdiction. The resulting interest payments
significantly reduce the Indian subsidiary's taxable income by claiming interest
payment as an expense while increasing the profits of the parent company which
is already situated in a low tax jurisdiction, affecting the tax collection in
India.
Definition of Associated Enterprises
To determine whether the lending entity qualifies as
an Associated Enterprise, the provision considers factors such as:
§
Control:
Direct or indirect control over the borrowing entity.
§
Shareholding:
A significant equity stake, typically 26% or more.
§
Voting
rights: Substantial influence through voting power.
Section 94B provides that where an Indian company or permanent
establishment of a foreign company being a borrower incurs any expenditure by
way of interest or similar nature exceeding Rs. 1 crore to its Non-resident
Associated Enterprises in respect of any debt issued as mentioned in the
following cases then excess interest shall be disallowed:
Debt
issued by Associated Enterprises or
Debt
issued by a lender which is not associated but an Associated Enterprise either
provides an implicit or explicit guarantee to such lender or deposits a
corresponding and matching amount of funds with the lender,
Provided
that nothing contained in the said provision shall be applied to interest paid
in respect of a debt issued by a lender which is a permanent establishment in
India of a Non-resident engaged in the business of banking.
Cap on Interest Deduction
Excess interest shall be disallowed where the excess
interest shall mean the lower of:
§
Total
interest paid or payable in excess of 30% of Earnings Before Interest, Taxes,
Depreciation, and Amortization (EBITDA) of the borrowing entity for a given
financial year or,
§
Interest
paid or payable to Associated Enterprises for that previous year, whichever is
lower
For example: If an Indian company has an EBITDA of
?100 crore and pays ?50 crore as interest to an Associated Enterprise, and no
interest is paid to a non-associated enterprise
§
Solution:
Interest that shall be disallowed will be lower of:
§
Excess
over 30% of EBITDA = 20 Crore
[50Crore – 30 crore (being 30% of EBITDA)] or,
§
50 Crore
(being the interest paid to the associated entity)
Hence, 20 crore will be disallowed
Carry Forward of Excess Interest
The disallowed interest can be carried forward for
up to eight consecutive assessment years and deducted in subsequent years,
subject to the 30% EBITDA cap in those years.
Interest deductions and other
financial payments - BEPS Action Plan 4
The term “base
erosion and profit shifting” means, tax planning strategies that exploit gaps
and mismatches in tax rules to make profits 'disappear' for tax purposes or to
shift profits to locations where there is little or no real activity but the
taxes are low .
WHAT IS
“BASE EROSION AND PROFIT SHIFTING” (BEPS) ?
§ Shifting of profits /income to low-tax jurisdictions
or other locations enabling a more favorable tax treatment
§ Arrangements involving double non-taxation or less
than single taxation
§ Transfer of intangibles to favorable tax
jurisdictions
§ Stripping legal entities of business functions,
assets and risks
§ Use of “tax attributes” such as tax credits,
loss-carry forwards, etc
§ Use of intermediary companies/ jurisdictions in
investment and financing structures
§ Use of hybrid arrangements to exploit mismatches in
tax treatment
Base
erosion and profit shifting (BEPS) Action Plan 4 is intended to address the
interest deduction claimed by multinational corporations by advancing money by
way of loan to AEs in different tax jurisdictions and deriving interest income
which is a charge on profits of the paying entity who end up paying income-tax
on the balance residue income. Instead of participating in the form of equity,
the multinationals resort to lending on interest in which case the AE unit
located in source jurisdiction pay income-tax after charging interest. In the
same scenario if the funds were taken as equity, there would not be base
erosion of income of the source entity and tax outgo in the source jurisdiction
would have been much larger.
The BEPS
Action Plan in 2015 report gave guidance on the design and operation of the
group ratio rule and approaches to deal with risks posed by banking and
insurance sectors.
There are
three methods in which the interest deduction could be moderated they are as
under:
(i) Fixed
ratio rule: Where the
interest expenditure on EBITDA is computed on a fixed ratio or limit such as
section 94B presently implemented in India.
(ii) Group
ratio rule: Where the
interest expenditure is allowed in the source jurisdiction based on the overall
group ratio of the entity's interest expenditure on its worldwide income. This
approach too, is not followed in India. The consolidated EBITDA of the group
vis a vis the consolidated interest expenditure of the group is applied for
deciding the proportion of interest expenditure allowable in a source
jurisdiction.
(iii) Targeted rules: Which is
to address specific risks by targeting transactions between related parties and
back-to-back arrangements which may be made to inflate the interest expenditure
without a corresponding economic cost.
Compliance Requirements for Companies
To ensure
adherence to Section 94B, companies must:
(i)
Assess Debt-to-Equity Ratios
Businesses should evaluate their capital structure
to avoid over-reliance on debt from Associated Enterprises. Maintaining a
balanced debt-to-equity ratio can mitigate the risk of disallowed interest
deductions.
(ii)
Monitor Interest Payments
Companies must closely monitor interest expenses to
ensure they remain within the 30% EBITDA threshold.
(iii)
Maintain Proper Documentation
Detailed records of borrowing arrangements, interest
payments, and the relationship with Associated Enterprises are essential for
demonstrating compliance during tax assessments.
(iv)
Utilize Carry-Forward Provisions
Firms should effectively manage the carry-forward of
disallowed interest to optimize deductions in future years.
Amount of interest that is
disallowed as per section 94B
§ Section 94B refers to the amount to be
disallowed as “Excess Interest”
§ Excess Interest is the lower of the following,
Total
interest paid or payable in excess of 30% of EBITDA of the borrower in the
financial year. (or)
Interest
paid or payable to the associated enterprises in the financial year.
Working of Section 94B
Working
of Section 94B is illustrated as follows:
|
S. No. |
Particulars |
Financial
year 2017-18 |
Financial
year 2018-19 |
Financial
year 2019-20 |
|
1. |
Earnings
Before Interest, Taxes, Depreciation, and Amortization (EBITDA) |
100 |
100 |
100 |
|
2. |
Interest
paid/payable to a non-resident AE |
15 |
35 |
50 |
|
3. |
Interest
paid/payable to unrelated parties |
35 |
15 |
0 |
|
4. |
Total
interest expenditure (2+3) |
50 |
50 |
50 |
|
5. |
30
per cent of EBITDA (allowable limit) |
30 |
30 |
60 |
|
6. |
Interest
paid/payable during FY over the allowable
limit |
20 |
20 |
0 |
|
7. |
Excess
interest is least of (2) and (6) |
15 |
20 |
0 |
|
8. |
Interest
of the current year allowed [Total interest
- Excess interest (i.e. (4) - (7)] |
35 |
30 |
50 |
|
9. |
Disallowed
interest is carried forward to succeeding
8 years [(4) - (8)] and set-off to the
extent of allowable limit |
15 |
35
(20-current year
add 15 -earlier
years) |
(10) [10
(setoff of b/f disallowed interest), 25
(c/f to succeeding years) |
|
10. |
Total
interest deduction allowed under the head
‘Profit and gains from business and profession’
during the FY [(8) add set-off under
(9)] |
35 |
30 |
60 |
NOTE
In
the above illustration, the interest payments to a non-resident AE in Financial
year 2017-18 is less as compared to interest payments to unrelated parties i.e.
30 % of total interest expenditure, which indicates that eroding tax base of
India may not be the main purpose of the taxpayer. However, the interest paid
to such AE shall be disallowed under section 94B of the Income tax Act, 1961.
Disallowed excess interest can be
carried forward to subsequent years
§ Disallowed excess interest can be carried forward
for a maximum of 8 Assessment years and can be used as deduction against PGBP
income.
§ The carried forward excess interest shall also be
subject to the provisions of section 94B while determining the allowable amount
in the subsequent years.
Assessee company issued CCD to its AE and claimed same to be at ALP but TPO characterised CCDs issued by assessee as equity and held that ALP of said interest was NIL, since Tribunal in Summit Development (P) Ltd. v. DCIT [IT (TP) Appeal No. 794 (ITAT Bangalore) of 2022, held that CCD was in nature of debt and cannot be recharacterized as equity till time same is converted into equity, impugned TP adjustment with reference to payment of interest on CCD was deleted
During relevant assessment year 2018-19, assessee
had issued Compulsory Convertible Debentures (CCD) to WeWork Netherlands. During
relevant assessment year assessee paid an interest of Rs. 1.85 crores to WeWork
Netherlands. Since assessee’s payment to WeWork Netherlands was at 6 per cent
on CCDs as compared to arm’s length range at 10-11 per cent, said international
transaction was concluded to be at ALP in its TP study. TPO recharacterised
CCDs issued by assessee to WeWork as equity and held that ALP of said interest
was NIL. Tribunal in case of Summit
Development (P) Ltd. v. DCIT [IT(TP) Appeal No. 794 [(ITAT Bangalore) of 2022] held
that CCD are in nature of debt and cannot be recharacterised as equity till
time same is converted into equity. Assessee had duly made disallowance under
section 94B in its return of income for relevant assessment year and, hence, it
could not be disallowed under TP provisions on same basis. Impugned TP
adjustment with reference to payment of interest on CCD was to be deleted. [In
favour of assessee] (Related Assessment year : 2018-19) - [WeWork India Management (P) Ltd. v. DCIC(TP)
[2023] 150 taxmann.com 432 (ITAT Bangalore)]
Rejects recharacterisation of preference shares as debt; Denies notional taxation of premium before redemption
Bangalore
ITAT allows Assessee’s appeal, deletes addition of Rs. 17.09 Cr made on account
of notional premium receivable on preference shares as Assessee’s income; Holds
that Revenue cannot disregard the legal effect of issue of cumulative
preference shares and say that the same is akin to debt, observes, “Such
a course is permissible under the thin capitalization rules which were
introduced with effect from 01.04.2018 by virtue of the provisions of Section 94B…,
but those provisions are applicable only in the case of transactions with
Associated Enterprise which is not a tax resident of India.”, that is
not the situation in the instant case; During the Assessment year 2016-17,
Assessee-Company invested an amount of Rs.130 Cr in preference shares of
Ensource Consulting (P) Ltd., redeemable at the end of 20 years from
the date of allotment, at a premium of 16.5% p.a.; Although in the original
return of income filed, Assessee offered Rs. 17.09 Cr as premium accrued on
redeemable preference shares under the head income from other sources, in the
revised return such income was not offered to tax because the
premium is to liable tax at the time of redemption of shares
under the head Capital Gains, only to the extent of actual
receipt; Revenue rejected Assessee’s contention and held the premium to be
taxable as Income from Other Sources on the basis that: (i)
Preference shares subscribed to by the Assessee contains features of
equity and debt as the dividend payments to preference shareholder is fixed
from the very beginning and (ii) Assessee follows mercantile system
of accounting, the taxability of the premium does not depend
upon actual receipt; CIT(A) upheld the
addition; ITAT concurs with Assessee’s submission that the
payment of redemption premium can be only out of profits of the company or out
of reserves and even if one were to regard the premium as akin to dividend, the
Assessee cannot claim dividend as a matter of right and it is for the directors
of the Company to declare dividend which needs to be approved by the
shareholders in an AGM; ITAT remarks, “by no stretch of
imagination can it be said that the preference shares issued to the assessee is
in the nature of equity”, explains that inference of accrual of premium
akin to accrual of interest in case of a loan cannot be drawn and the repayment
of the face value of the preference shares as well as the premium on redemption
is uncertain; Holds that “the revenue authorities cannot disregard the
legal effect of issue of cumulative preference shares and say that the same is
akin to debt…”¸ relies on Bombay High Court ruling in CIT
v. Enam Securities (2012) 345 ITR 64 (Bom.) wherein
High Court categorically held that “There is fundamentally as a matter of
first principle and in law a clear distinction between bonds and debentures on
the one hand, and preference share capital on the other.”, and rejected
Revenue’s action of recharacterizing non-cumulative redeemable preference
shares as ‘debt’; Opines that such an action is permissible only under the thin
capitalisation rules under Section 94B introduced with effect from 01.04.2018
and applicable only to transactions with non-resident AEs; As regards Revenue’s
contention of disallowing interest expense arising from loan taken to invest in
the shares under Section 14A, following the matching concept, ITAT concurs with
Assessee’s contention that premium on redemption of debentures is taxable in
the year of redemption and hence there was no exempt income whatsoever
warranting invocation of the provisions of Section 14A; Separately, ITAT holds
that interest paid on delayed remittance of TDS is not an allowable deduction
relying on Madras High Court ruling in Chennai Properties and
Investments Ltd. [In favour of
assesse] (Related Assessment
year : 2016-17) – [Enzen Global Solutions (P) Ltd. v. ITO [TS-739-ITAT-2022(Bang)]
– Date of Judgement : 19.09.2022
(ITAT Bangalore)]
An application for advance ruling filed by assessee on issue
of applicability of provision of section 94B on interest and bank guarantee fee/guarantee commission
paid by it to banks and to its non-resident AE was filed prior to issue of
notice under section 143(2) in case of assessee and, thus, no proceeding was
pending on date of filing of said application, impugned application was to be
admitted
Assessee availed credit facilities
from various Indian banks and Indian branches of foreign banks for which it had
furnished a counter guarantee from its non-resident AE. In connection of these
credit facilities assessee had to pay interest and bank guarantee fee to banks
and also counter guarantee fee/guarantee commission to its non-resident AE. Thereafter,
provision of section 94B was introduced vide Finance Act, 2017 which puts
certain restriction on deduction of interest, guarantee fee commission etc. in
respect of any debt issued by a non-resident, being an AE of borrower. Assessee
filed instant application on issue of applicability of provision of section 94B
on interest and bank guarantee fee/guarantee commission paid by it - Revenue
raised objection to admission of said application on grounds that, firstly,
question raised in said application was pending with Assessing Officer in
scrutiny proceedings and; secondly, clause (iii) of proviso of section 245R(2)
was attracted as transaction or issue was designed prima facie for avoidance of
income-tax. It was noted that it was found that notice under section 143(2) was
issued in this case for assessment year 2018-19 on 29.11.2019 whereas instant
application was filed much earlier on 03.04.2019 - Thus, no proceeding was
pending on date of filing of instant application. Further, revenue had not
brought on record any fact to establish that claim of applicant in respect of
interest, guarantee fee and guarantee commission was sham or nominal or that
claim was only a contrived device solely with a view to avoid tax. Merely
because applicant had raised questions regarding applicability of provisions of
section 94B, it could not be considered as a ‘transaction designed to avoid tax’.
On facts, impugned application for advance ruling filed by assessee was to be
admitted. [In favour of assessee] – [Doosan
Power Systems India (P) Ltd., In re (2021) 124 taxmann.com 425 (AAR - New
Delhi)]
Capital borrowed from shareholders - Interest on debt capital borrowed from shareholders resulting in abnormally high debt-equity ratio, No interest disallowance in absence of any thin capitalization rule despite high debt-equity ratio; Absence of thin capitalisation rules in India key factor in allowing deduction; Upholds ITAT ruling in Besix Kier Dabhol SA
Assessee company was a
Belgium-based company engaged to carry out the project of construction of fuel
jetty in India. Its equity capital was divided in the ratio of 60:40 between
the two joint venture partners and it also borrowed from its shareholders in
the same ratio as the equity share holding. In the circumstances, the
respondent had equity capital of Rs. 38 lakhs and debt capital of Rs. 9410
lakhs. Thus, debt equity ratio worked out to 248:1. It paid interest to its joint venture
partners on a loan outstanding against it. The Assessing Officer disallowed the
payment of interest which was confirmed by the Commissioner (Appeals).
Before the Tribunal the case of the
revenue was that the debt capital was required to be re-characterised as equity
capital. However, the Tribunal held that in India as the law stands there are
no rules with regard to thin capitalization so as to consider debt as an
equity. The Tribunal allowed the payment of interest.
Held : There is no fault with the
finding of the Tribunal. There were not at the relevant time, and even today
there are no thin capitalization rules in force. Consequently, the interest
payment on debt capital cannot be disallowed.[In favour of assessee] (Related Assessment year : 2002-03) – [Director of Income-tax, International Taxation,
Mumbai v. Besix Kier Dabhol SA (2012) 26 taxmann.com 169 : [TS-661-HC-2012(BOM)]
(Bom.)
NOTE
High Court
has however, admitted the following questions of law raised by the Revenue.
‘Whether
on the facts and circumstances of the case and in law the Tribunal was right in
holding that the deduction of interest claimed was under section 36(1)(iii) and
not under section 37 of the Act as held by the CIT(A)?
‘Whether
on the facts and circumstances of the case and in law the Tribunal was right in
holding that the profit of the assessee company liable to be taxed in India are
its entire profits taxable in India and all its expenses are deductible in
ascertainment of its taxable income ignoring the fact that the interest payment
was made to the share holders of the assessee with the debt equity capital
ratio of 248:1 and which can be considered as payment to self covered by the
provisions of Article 7(3)(b) of the DTAA and, therefore, not allowable
expenditure?'
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