Thin Capitalization Rules

The Income-tax Act (“ITA”) curbs companies from enjoying excessive interest deductions.

The Finance Bill 2017 has proposed to introduce thin capitalization rules within the Income-tax Act (“ITA”) to curb companies from enjoying excessive interest deductions, while effectively being akin to an equity investment. This move would have a significant impact on investments into India through the debt route – both in respect of Compulsorily Convertible Debentures (“CCDs”), Non-Convertible Debentures (“NCDs”), and External Commercial Borrowings (“ECBs”), which are widely used methods for funding into India. The Finance Bill proposes the introduction of Section 94B (“Thin Capitalization Rules”) to provide that where an Indian company or PE of a foreign company makes interest payments (or similar consideration) to its associated enterprise, such interest shall not be deductible at the hands of the Indian company/PE to the extent of the “Excess Interest”.

As per the proposed Section 94B(1), these provisions will be applicable to:

Borrower: either an Indian company, or a permanent establishment (“PE”) of a foreign company in India. However, these provisions will not be applicable if they are engaged in the business of banking or insurance.

Lender: interest is paid in respect of any debt issued by a non-resident, being an associated enterprise (“AE”) of such borrower.

The definition of AE as provided under subsection (1) and subsection (2) of section 92A shall apply for the purposes of this section also.

• Threshold: The amount of interest or similar consideration exceeds INR one crore rupees
• Nature of expense: interest or similar consideration exceeding one crore rupees paid by the borrower which is deductible in computing its income chargeable under the head “Profits and Gains of Business or Profession”