Section 94B caps the deduction where an Indian company or the Indian permanent establishment of a foreign company pays interest exceeding Rs 1 crore in a year to a non-resident associated enterprise: the deductible amount is limited to 30% of EBITDA, and the excess is carried forward for up to eight assessment years. It applies from assessment year 2018-19 and has recently been held, in at least one tribunal decision, to be overridden by the non-discrimination article of a tax treaty.
The mischief is familiar. A foreign group can fund its Indian subsidiary with debt rather than equity, strip the Indian profit out as deductible interest, and pay a low withholding rate on it. Section 94B, inserted by the Finance Act 2017 with effect from 1 April 2018 and so applying from assessment year 2018-19, implements the OECD's BEPS Action 4 fixed-ratio approach to that.
The gate is Rs 1 crore. The section bites only where interest or similar consideration in respect of debt issued by a non-resident associated enterprise exceeds one crore rupees and is deductible in computing business income. Below that, nothing changes.
The cap is 30% of EBITDA — earnings before interest, taxes, depreciation and amortisation. The disallowable amount, the "excess interest", is the total interest paid or payable to associated enterprises less the lower of 30% of EBITDA and that interest figure. So the restriction never disallows more than what was paid to associated enterprises, however thin the EBITDA.
The associated-enterprise test reaches beyond direct lending. Where the actual lender is not an associated enterprise but an associated enterprise provides an implicit or explicit guarantee to that lender, or deposits a corresponding and matching amount of funds with it, the debt is deemed to have been issued by an associated enterprise. Back-to-back structures through a bank therefore do not escape.
There are carve-outs. An Indian company or permanent establishment engaged in the business of banking or insurance is outside the section, and notified non-banking financial companies were later added. A further exclusion covers interest paid in respect of debt issued by a lender that is a permanent establishment in India of a non-resident engaged in the business of banking — commentary places that at assessment year 2021-22 via the Finance Act 2020.
Disallowance is deferral rather than denial. Interest disallowed in a year is carried forward and allowed against business profits of the following years, subject to the same 30% test in each of those years, for not more than eight assessment years immediately succeeding the assessment year of the first disallowance. There is no carry back.
The treaty argument is now live. Section 94B restricts deductibility only where the lender is a non-resident associated enterprise; an identical loan from a resident associated enterprise is not touched. Deduction non-discrimination articles in India's treaties require interest paid to a resident of the other state to be deductible under the same conditions as if it had been paid to a resident. In Vestas Wind Technology India Pvt Ltd v. ITO for assessment year 2018-19 the Chennai Tribunal accepted that argument under Article 24(4) of the India–Denmark treaty and deleted the entire section 94B adjustment, noting that the transfer pricing officer had already accepted the interest as being at arm's length so the special-relationship article in the interest clause did not apply.
For a leveraged Indian subsidiary in a loss or low-EBITDA year, 30% of EBITDA can be close to nothing, so almost the whole interest bill becomes non-deductible in that year even though it is commercially real and priced at arm's length. The carry-forward only helps if profits arrive within eight years. The treaty non-discrimination route is now the main line of defence and turns on which treaty applies.
We outsource back-office work to our Indian subsidiary. Does that give us a permanent establishment in India?
My protocol has an MFN clause and I applied the lower rate India later agreed with an OECD member. Was I entitled to?
I am resident in India but my rubber estate and my business are in Malaysia. The treaty says that income may be taxed there. Can India tax it as well?
You pay a foreign supplier for software. Is that royalty, and must you deduct TDS?
Our turnkey contract has offshore supply and offshore services alongside Indian work. Is the whole contract taxable in India?
I hold a valid TRC. Can the AO go behind it and reopen my assessment for lack of substance?
I paid administrative fees to my US group company without deducting TDS and the officer has disallowed the whole amount under section 40(a)(i). Can I use the treaty's non-discrimination article?
My Indian company paid DDT at over twenty per cent on dividend to its UK parent. Can I restrict it to the ten per cent treaty rate, and does the Special Bench decision stop me?
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