Limitation of Interest deduction in certain cases
The Concept and reason of introducing Section 94B or Limitation of Interest deduction in certain cases
A company is typically financed or capitalized through a mixture of debt and equity. The way a company is capitalized often has a significant impact on the amount of profit it reports for tax purposes as the tax legislations of countries typically allow a deduction for interest paid or payable in arriving at the profit for tax purposes while the dividend paid on equity contribution is not deductible. Therefore, the higher the level of debt in a company, and thus the amount of interest it pays, the lower will be its taxable profit. For this reason, debt is often a more tax efficient method of finance than equity. Multinational groups are often able to structure their financing arrangements to maximize these benefits. For this reason, country’s tax administrations often introduce rules that place a limit on the amount of interest that can be deducted in computing a company’s profit for tax purposes. Such rules are designed to counter cross-border shifting of profit through excessive interest payments, and thus aim to protect a country’s tax base.
In view of the above, a new section 94B was introduced , in line with the recommendations of OECD BEPS Action Plan 4, to provide that interest expenses claimed by an entity to its associated enterprises shall be restricted to 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to associated enterprise, whichever is less.[Section 94(2) of Income Tax Act 1961]
For Example if A Ltd ( A UK based Holding Company) gives loan to B Ltd ( A India Based Subsidiary Company) in FY 18-19
Amount of Loan Rs 100 Cr @ 10% interest PA.
EBITDA of B Ltd. Rs. 5 Cr.
Here the limited interest deduction which can be taken is 30% of Rs. 5 Cr. i.e. 1.5 Cr.
The disallowed interest expense shall be carried forward to eight assessment years immediately succeeding the assessment year for which the disallowance was first made and deduction against the income computed under the head “Profits and gains of business or profession to the extent of maximum allowable interest expenditure. [Section 94(4) of Income Tax Act 1961]
As per Section 94(4) of Income Tax Act 1961 the disallowed interest in above example i.e. Rs. 8.5 Cr (Rs. 10 Cr minus Rs. 1.5 Cr) can be carried forward to eight assessment years immediately succeeding AY 19-20.
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