Taxability of Interest Income of Non-Resident

In this article, analysis is being done on Tax Rate applicable on Interest income to Non-resident.

The Tax Rates on interest income to non-resident is dependent upon following 3 crucial factors:-

a. Nature of currency in which borrowing is done by borrower in India, whether Indian Rupee or foreign currency.

b. Source of borrowing, whether amount is borrowed from India or outside India.

c. Special Tax treatment to specific borrowings under Income Tax Act, 1961.

Tax Rates on interest income of Non-Resident is governed by provision of Income Tax Act and DTAA, whichever is beneficial.

Before evaluating the impact of above-mentioned 3 factors on taxability of Interest income, lets re-visit the provisions of Income Tax Act and DTAA, with reference to Interest Income to Non-resident, in succinct manner:-

Income Tax Provisions

Section 115A- Providing for concessional Tax Rate on interest income of Non-resident as under:-

a. Tax rate is 20% on Gross Interest Income on money borrowed in foreign currency by Indian Borrower. (U/s section 115A(1)(ii))

b. Tax rate is 5% on Gross Interest Income from Infrastructure debt fund referred to in section 10(47). As per RBI Guidelines, eligible Non-resident investor is permitted to invest in both Foreign Currency and Rupee denominated bonds and rupee denominated units issued by IDFs. (U/s section 115A(1)(iia))

c. Tax rate is 5% on Gross interest income referred to in section 194LC. Section 194LC refers to Interest arising to Non-resident on money lent in Foreign currency from source outside India in following cases:-

i. Under loan agreement at any time on or after 01/07/2012 but before 01-07-2017.

ii. By subscribing long term infrastructure bonds issue at any time on or after 01/07/2012 but before 01-10-2014.

iii. By subscribing long term bonds including long-term infrastructure bonds issue at any time on or after 01/10/2014 but before 01-07-2017.

(U/s section 115A(1)(iiaa))

Under said section interest is taxable on Gross basis, without deduction for any expenditure.

Normal Provision

Interest income, other than referred to in section 115A, is taxable on Net basis, at rates applicable to Non-Resident as under:-

Non-Resident Tax payer	Tax Rates for Recipient	TDS Rate to be applied by Borrower
Company	40%	40%
Individual	Slab System	30%

Double Taxation Avoidance Agreement (DTAA)

Taxability of Interest income is governed by Article 11 of UN Model Convention, as under:-

a. Article 11(1)- Residence state of Non-resident get right to tax interest income receiving from Other state (Source state) (Say India)

b. Article 11(2) – Source state (say India) get taxing right on such interest income at negotiated rates (Generally between 10-15%) on Gross Interest amount.

c. Article 11(4)- Instead of taxing interest income on Gross basis, source state gets taxing right on net basis in case where Non-Resident carries business in source state (say India) through PE and debt claim in connection with interest arises is effectively connected with PE. In such case interest income is considered as part of PE income and source state taxes the same accordingly on net basis.

The interplay of the above-mentioned three factors in juxtaposition with the provisions of Income Tax Act and DTAA is summarised as under:-

S.No	Factor	DTAA	Income Tax Act Provision
1.	Nature of Currency	The allocation of taxing rights between Residence and Source state, including quantum of tax to be levied by source is not dependent upon Nature of Currency.	Tax rate varies depending whether amount is borrowed from Non-resident in foreign Currency or Indian Rupee. Tax Rate is 20% on Gross basis u/s Section 115(1)(ii) where amount is borrowed in foreign Currency Tax rate is 40% on net basis (net of expenditure), where money is borrowed in Indian Rupee.
2	Source of Borrowing	Depending upon the source of borrowing, i.e whether directly from Residence state or from PE, source state gets taxing right on gross basis or net basis respectively.	The Source of borrowing has no impact on tax rate applicable to interest income of Non-Resident.
3.	Special Treatment	DTAA has no role to play	There is special concessional rate in certain circumstances like interest from Infrastructure debt fund or as referred to in section 194LC

Tax Rates on Interest Income of Corporate Non-Resident

The tax rates are variable based on following two factors:-

a. Nature of Currency

b. Source of Borrowing

The special concessional rates as provided in the Act are not considered in below stated analysis.

The applicability of Tax rates are considered by Keeping one factor constant and other factor variable as under:-

Nature of Currency – Foreign Currency

S.No	Particulars	Source of Borrowing
S.No	Particulars	From Foreign State	From PE in India
1.	Example	Normal borrowings under ECB Guidelines	Borrowings from Branches of foreign bank in India (like Citi Bank, HSBC etc)
2	Tax Rate applicable to Non-Resident	20% (Plus Surcharge, if any, & EC) u/s 115A or rate under Article 11(2) of DTAA, whichever is lower, on Gross Interest in both the cases.	20% u/s 115A on Gross Interest or 40% on net Interest (Net of expenditure) under Normal Provisions, whichever is lower. The Surcharge, if any & EC is applicable in both cases.
3	TDS rate to be applied by Indian Borrower	Same as above	20%, plus applicable Surcharge & EC or Rate on the basis of lower TDS certificate obtained by Non-Resident.

Nature of Currency – Indian Rupees

S.No	Particulars	Source of Borrowing
S.No	Particulars	From Foreign State	From PE in India
1.	Example	Rupee loan under ECB Guidelines under specified cases.	Rupee loan from Branches of foreign bank in India (like Citi Bank, HSBC etc)
2	Tax Rate applicable to Non-Resident	40% (Plus Surcharge, if any, & EC) on net basis (Net of expenditure) under normal provisions or rate under Article 11(2) of DTAA on Gross basis, whichever is lower	40% (Plus Surcharge, if any, & EC) on net Interest (Net of expenditure) under Normal Provisions.
3.	TDS rate to be applied by Indian Borrower	Rate under Article 11(2) of DTAA If there is no DTAA, then 40% (Plus Surcharge, if any, & EC) or lower rate as per Lower TDS certificate	40% (Plus Surcharge, if any, & EC) or lower rate as per Lower TDS certificate.