Table of Contents
1. Section 94B of the Income-tax Act, 1961
- Section 94B of the income tax act contains provisions relating to the deduction of interest expenditure incurred by an Indian company or a permanent establishment of a foreign company.
- Any interest over and above the prescribed limit (as contained in this section) shall not be allowed as deduction in the year of accrual or payment.
2. 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.
3. 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.
4. What do you mean by a permanent establishment?
- Permanent establishment means a fixed place of business through which the business of the enterprise is wholly or partly carried on.
5. What is the maximum limit upto which the provisions of section 94B will not apply?
- The provisions of this section will not be applicable if the amount of interest or any expenditure of similar nature does not exceed 1 Crore in a financial year.
6. Non applicability of section 94B
- The provisions of section 94B shall not apply,
- To an Indian company or permanent establishment of a foreign company that is engaged in the business of banking and insurance. (or)
- In respect of interest paid to a debt issued by a non-resident banking company whose permanent establishment is situated in India
7. What is the scope of debt/borrowing as per this section?
- Debt/borrowing for the purpose of applicability of this section includes any loan, financial instrument, financial lease, financial derivative, or any arrangement that gives rise to interest, discount or other finance charges.
8. What is the amount of interest that is disallowed as per section 94B?
- This section 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.
- Note: EBITDA means Earnings before Interest, Tax, Depreciation and Amortization.
9. Can the disallowed excess interest 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.
10. Situation:
Borrower – X ltd (foreign company having place of effective management in India)
Lender – Z Ltd (Non- resident associated enterprise)
Will the Provisions of section 94B apply?
- The provisions of section 94B will apply only if the money is borrowed by an Indian company or a permanent establishment of a foreign company.
- In this case, the borrower (X ltd) is a foreign company with place of effective management in India – which makes X ltd a resident company but not an Indian company as per section 2(26) of the Income tax act, 1961.
- Assuming, X ltd does not have any permanent establishment in India even though the place of effective management is in India. X ltd does not qualify to be a borrower for the applicability of section 94b
- In light of the above, Section 94B shall not be applicable with respect to interest paid by a foreign company having place of effective management in India.