The use of excessive debt by companies in India or permanent establishment of foreign companies has received a blow from the budget this year as it proposes to restrict the deduction of interest expenses claimed by these companies.
Complying with the BEPS Action plan 4, the budget has introduced a new section 94B which restricts the deduction of interest expenses, exceeding Rs 1 crore, claimed by an Indian company or a Permanent Establishment of a foreign company in India in respect of loan taken from non-resident associated enterprises to 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA).
The disallowed interest expense can be carried forward and set off up to 8 subsequent years. This provision will also cover loan taken from third parties, but guaranteed by an associated enterprises.
Earlier, there were no limit on the deduction claimed on interest expenses. "Due to this move, the companies which are highly financed by debts from their associated enterprises will need to restructure the funding of Indian operations," says Rohinton Sidhwa, Partner, Tax - International Tax, Deloitte India.
Paresh Parekh, tax partner, EY India, said that the move could pose some serious challenges to India Inc especially for leveraged sectors like infrastructure.
"The use of excessive debt in companies to avail of interest expense to reduce taxable income has been a subject matter of debate under the tax policy of several countries for years now. Most countries have thin capitalization rules, which empower tax authorities to re-characterize debt into equity to check this tax avoidance technique," explains Amit Singhania, partner, taxation, Shardul Amarchand Mangaldas & Co.
It is to be mentioned here that India's General Anti-Avoidance Rule (GAAR) has also empowered tax authorities to re-characterize debt into equity.
Base Erosion and Profit Shifting (BEPS) is tax avoidance techniques used by corporation by shifting their profits to low or no-tax locations. The BEPS action plan is a set of rules put forward by over 100 countries to check these practices.