Budget 2019: Debt investment in India – delivering clarity on thin capitalization


Section 94B has been introduced vide Finance Act 2017 to implement BEPS Action Plan 4 limiting interest deduction for thinly capitalised company. India has adopted the fixed ratio rule on earnings before interest, tax, depreciation and amortisation (EBITDA) – interest to the extent of 30 percent of EBITDA shall be allowed for deduction of interest payment to non-resident associated enterprise or deemed to be associated enterprise.

Any excess interest not allowable will be carried forward for 8 years for set-off in future. Further, for interest payment below INR 10 Million, the said section is not applicable. The basic underlying principle for introduction of said section was that the tax legislations 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. To address said issue, section 94B was introduced.

However, section 94B even covers interest paid to non-resident third party, if guarantee is provided by associated enterprise without any debt being directly issued by it. Such an arrangement gives rise to income of non-related party and does not result in erosion of base by specifically structuring an arrangement within the group. Considering the said proposition and with such a stringent measure being adopted by a country which is not capital-rich, it is bound to adversely impact debt investment in India.

India has abundant labour and considering that it is still a developing country, such measures will negatively impact flow of funds into India. Investment in India in the form of loans, which are available at lower rate of interest outside India, should not be disallowed considering tax perspective of base erosion in isolation especially when debt-equity ratio has already been prescribed in guidelines to External Commercial Borrowing (ECB) by the Reserve Bank of India.

Thus, it is expected that the said section will be relaxed especially for scenarios where payment of interest is made to third party backed by guarantee from associated enterprises. This is more so considering that ECB may have impact on employment, income generation for country, which is a key agenda for the government recently re-elected.

Further, it is also expected that the fixed rule of 30 percent will be relaxed considering the government agenda for ease of doing business in India, more specifically for startups, keeping in mind the initiatives taken the for ‘Make in India’ programme.

Thus, there is a lot to be thought of by the government for provisions of interest deduction under tax laws, bearing in mind the need for capital and investments in India. Furthermore, clarity and certainty on said section would certainly provide boost for investment in India for which it is expected that provisions of section 94B will be relaxed and clarity will be delivered in Budget 2019. 


Author: Ayaan