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INDIA Inc. is for some interesting times with the exchange rate hitting the roof. The Government is doing its bit to attract foreign debt. Be it the announcement made during the Budget exercise or the recent amendments made to the Foreign Exchange legislation permitting foreign retail investors to invest into equity and bonds issued by Indian Inc. or the infrastructure debt fund regulations. Based on statistics as are available on the RBI website, it is noted that annual foreign debt (ECB, FCCB, etc.) obtained by India Inc. increased from USD 18 billion in FY 2008-09 to USD 35 billion in FY 2011-12. There is an expectation that these numbers may go up considering the amendments proposed by the Government to attract foreign capital. Having said that, the cost of debt will also need to be looked at by India Inc. very carefully. The cost of debt comprises of many components, amongst which is included the ability to claim deduction for interest paid on such debt as well as the India income-tax liability of the lender providing such debt.

In so far as it relates to the India income-tax liability of the lender, India Inc. has negotiated agreements where under tax is withheld at source and net amount is paid to the lender or where India tax is borne by the Indian party, which increases the cost of capital in the hands of the borrowing entity.

The recent amendment made to the Indian tax legislation by reducing the rate of withholding tax on interest paid to a non-resident or a foreign company from 20% to 5% is a welcome step. This will surely help reducing the cost of capital for India Inc. where the tax liability is to be borne by the Indian entity and even in situations where the tax is to be withheld at source, the lender may consider the lower withholding tax in India and consider that in pricing the debt.

In the Finance Bill, 2012 as was originally presented, the benefit of lower withholding tax was to apply only to infrastructure sectors, like, power, airlines, dams, etc, however as the Finance Bill was finally passed, this benefit was extended to all the Indian companies being the payer. To avail of the lower rate of withholding tax:

• Monies should be borrowed in foreign currency from a source outside India;

• Monies must have been borrowed between 1 July, 2012 and 30 June, 2015;

• The borrowing should be under a loan agreement or by way of issue of long term infrastructure bonds; and

• The entire arrangement including the terms of loan or bonds, its repayment and interest amount should have been approved by the Central Government.

Tax payers not satisfying the above requirements have the recourse of applying the provisions of the Income-tax Act (applicable rate being 20%) or tax treaty, where applicable.

The benefit of lower withholding tax is significant, which should attract foreign investors to invest in the Indian debt and also provide a window for India Inc. to negotiate a better rate of interest. The amended law could create a win-win situation for the lenders and borrowers.

Every legislation does have interesting aspect. The amendment indicating lower rate of withholding on interest has its own fair share of interesting aspects – viz.,

(i) does one have to go to the Central Government for an approval for every debt that is proposed to be raised or will the guidelines specified under ECB Regulations suffice;

(ii) existing loans, whether these will be covered if monies are drawn between the specified period;

(iii) whether a loan taken to re-finance an existing debt will be covered, etc.

Some guidance from the revenue authorities on the subject would be useful. The most important being that there should be clarity on the requirement of approvals. If there is a requirement for an approval, appropriate machinery should be in place to look into this quickly to avoid any delays in opportunities that may be available for India Inc.

To sum it all, the amendments and efforts taken by the Government to attract foreign capital are commendable. It is a conscious effort by the Government to extend assistance to India Inc. by foregoing tax revenue (by way of reduction in the withholding tax rate) in challenging times.

Published by

CA Shail Shah
(Mergers & Acquisitions Tax)
Category Income Tax   Report

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