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TMI Bloglimitation on Debt interest deduction as expenses in cross-border transactions : Clause 177 of Income Tax Bill, 2025 Vs. Section 94B of Income-tax Act, 1961X X X X Extracts X X X X X X X X Extracts X X X X ..... ve analysis of Clause 177, compares it with Section 94B and Rule 21ACA, and discusses the implications for stakeholders, interpretational challenges, and the broader policy context. Objective and Purpose The core objective of Clause 177 (and its predecessor, Section 94B) is to prevent MNEs from eroding the Indian tax base through excessive interest deductions on cross-border debt, especially where the lender is an associated enterprise. The legislative intent is to align with international best practices, notably the OECD BEPS framework, and to ensure that India's tax regime is robust against profit shifting via thin capitalization structures. Historically, Indian tax law did not have a specific cap on interest deduction for payments to non-resident associated enterprises, which allowed MNEs to leverage Indian operations excessively and reduce taxable profits through high interest outflows. The introduction of Section 94B in 2017, and now its proposed codification and refinement in Clause 177, reflects a policy shift towards protecting the domestic tax base while maintaining investor confidence and clarity. Detailed Analysis of Clause 177 of Income Tax Bill, 2025 1. Scope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and where IFSC Finance Companies are subject to separate regulatory regimes designed to encourage international financial activity in India. 4. Determination of "Excess Interest" Clause 177(4) defines "excess interest" as the lower of: * Total interest paid or payable in excess of 30% of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) of the borrower in the tax year, or * Interest paid or payable to associated enterprises for that tax year. Section 94B(2) uses identical language and methodology. This fixed ratio rule is consistent with BEPS Action 4 and is designed to strike a balance between allowing legitimate interest deductions and preventing excessive deductions that erode the domestic tax base. 5. Carry Forward and Set-Off of Disallowed Interest Clause 177(5) and (6) permit the carry forward of disallowed interest expenditure for up to eight tax years, to be set off against future business profits, subject to the same 30% EBITDA limitation in subsequent years. Section 94B(4) contains an identical mechanism, with the carry forward period capped at eight assessment years. This approach prevents permanent disallowance of interest, recognizing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... years Terminology shift (assessment year to tax year) but substance unchanged Definitions "Debt," "Finance Company," "PE," etc. defined Same, with cross-references updated Alignment with new legislative framework The comparison reveals that Clause 177 is largely a re-enactment and consolidation of Section 94B, with minor clarifications and terminological updates to fit the new Bill's structure. The overall policy, mechanics, and exclusions remain unchanged. Specifics for Finance Companies in IFSCs :- Rule 21ACA of the Income-tax Rules, 1962 Rule 21ACA, notified in 2025, operationalizes the exemption for Finance Companies in IFSCs as provided u/s 94B (and now Clause 177). * It specifies permitted activities for such Finance Companies, including lending, guarantees, securitisation, factoring, forfaiting, and treasury functions. * It mandates that interest paid by such companies (as borrowers) in respect of debt issued by a non-resident must be in foreign currency. * Definitions are provided for "Finance Company" and "International Financial Services Centre." This rule ensures that only genuine, internationally-oriented financial operations benefit from t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are included/excluded, treatment of non-operating income, etc.) may be subject to interpretation and litigation. 2. Interaction with Transfer Pricing Provisions Section 94B/Clause 177 operates "notwithstanding anything contrary," but does not override the need for interest rates and terms to be at arm's length under transfer pricing rules (Sections 92-92F). Both provisions may apply cumulatively, potentially leading to double disallowance if not carefully coordinated. 3. Treatment of Hybrid Instruments The definition of "debt" is broad, including financial instruments, leases, derivatives, and arrangements that give rise to finance charges. The characterization of hybrid instruments (e.g., convertible debentures) may be contentious. 4. Carry Forward and Set-off Mechanism Carry forward is allowed for eight years, but only "to the extent of maximum allowable interest expenditure as per sub-section (4)" each year. This may require complex tracking and allocation, especially for groups with multiple financing arrangements. 5. Scope of Exemptions The exemption for "such class of non-banking financial companies as notified by the Central Government" introduces a discretionar ..... X X X X Extracts X X X X X X X X Extracts X X X X
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