Income Tax 2025

Appearance

Limitation on interest deduction in certain cases ​

177(1) ​

Irrespective of anything contrary in this Act, any expenditure by way of interest or similar payment in respect of excess interest, as specified in sub-section (4), shall not be deductible in computation of income chargeable under the head “Profits and gains of business or profession”, if,—

  • (a) it is paid or payable by an Indian company or a permanent establishment of a foreign company in India, in respect of any debt issued by an associated enterprise which is a non-resident; and
  • (b) the sum of such expenditure in a tax year exceeds one crore rupees.

177(2) ​

Where a lender, not being an associated enterprise, has issued a debt referred to in sub-section (1), such debt shall be deemed to have been issued by an associated enterprise if an associated enterprise has—

  • (a) provided an implicit or explicit guarantee to the lender in respect of such debt; or
  • (b) deposited a corresponding and matching funds with such lender

177(3) ​

The provisions of this section shall not apply to—

  • (a) interest paid in respect of a debt issued by a lender which is a permanent establishment in India of a non-resident engaged in the business of banking;
  • (b) an Indian company or a permanent establishment of a foreign company which is engaged in the business of banking or insurance or a Finance Company located in any International Financial Services Centre, or such class of non-banking financial companies as notified by the Central Government in this behalf.

177(4) ​

In sub-section (1), the “excess interest” means––

  • (a) In total interest paid or payable in excess of 30% of earnings before interest, taxes, depreciation and amortisation of the borrower in the tax year; or
  • (b) interest paid or payable to associated enterprises for that tax year, whichever is less.

177(5) ​

Interest expenditure not wholly deducted against income under the head “Profits and gains of business or profession” for any tax year shall be—

  • (a) carried forward to the following tax year or years; and
  • (b) allowed as a deduction against the profits and gains, if any, of any business or profession carried on by it and assessable for such tax year, to the extent of maximum allowable interest expenditure as per sub-section (4).

177(6) ​

The interest expenditure referred to in sub-section (5) shall not be carried forward for more than eight tax years immediately succeeding the tax year for which the excess interest expenditure was first computed.

177(7) ​

In this section,—

  • (a) “debt” means any loan, financial instrument, finance lease, financial derivative, or any arrangement that gives rise to interest, discounts or other finance charges that are deductible in the computation of income chargeable under the head “Profits and gains of business or profession”;
  • (b) “Finance Company” means a finance company as defined in regulation 2(1)(e) of the International Financial Services Centres Authority (Finance Company) Regulations, 2021 made under the International Financial Services Centres Authority Act, 2019 and which satisfies such conditions and carries on such activities, as prescribed;
  • (c) “permanent establishment” shall have the meaning assigned to it in section 173(c).
Explanation

Section Summary: ​

Section 177 of the new income tax law limits the deductibility of interest expenses for Indian companies or permanent establishments of foreign companies in India when the interest is paid to non-resident associated enterprises. The purpose is to prevent excessive interest deductions that could erode the Indian tax base, particularly in cases involving cross-border transactions with related parties.

Key Changes: ​

  1. Interest Deduction Cap: Interest expenses exceeding 30% of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) or ₹1 crore, whichever is less, are not deductible.
  2. Deemed Associated Enterprise: Even if the lender is not an associated enterprise, the debt is treated as issued by an associated enterprise if there is an implicit/explicit guarantee or matching funds deposited by an associated enterprise.
  3. Carry Forward of Excess Interest: Excess interest not deducted in a tax year can be carried forward for up to eight subsequent years, subject to the 30% EBITDA cap.
  4. Exemptions: Certain entities, such as banks, insurance companies, and finance companies in International Financial Services Centres (IFSCs), are exempt from these restrictions.

Practical Implications: ​

  1. For Indian Companies and Foreign Permanent Establishments:
    • Interest payments to non-resident associated enterprises exceeding the 30% EBITDA cap or ₹1 crore will not be deductible.
    • Companies must carefully track interest payments and EBITDA to ensure compliance.
  2. For Associated Enterprises:
    • Transactions involving guarantees or matching funds with associated enterprises will be scrutinized to ensure they are not used to circumvent the interest deduction limits.
  3. For Exempt Entities:
    • Banks, insurance companies, and certain finance companies in IFSCs are unaffected by these restrictions, allowing them to continue deducting interest expenses without limitation.

Critical Concepts: ​

  1. Excess Interest: The lower of:
    • Interest exceeding 30% of EBITDA, or
    • Interest paid to associated enterprises.
  2. Debt: Includes loans, financial instruments, leases, derivatives, or any arrangement that results in deductible interest or finance charges.
  3. Permanent Establishment: A fixed place of business in India through which a foreign company operates.
  4. Finance Company: Defined under the International Financial Services Centres Authority Act, 2019, and subject to specific conditions.

Compliance Steps: ​

  1. Calculate EBITDA: Determine earnings before interest, taxes, depreciation, and amortization for the tax year.
  2. Identify Interest Payments: Track all interest payments made to associated enterprises and non-associated lenders.
  3. Apply the 30% Cap: Ensure that deductible interest does not exceed 30% of EBITDA or ₹1 crore, whichever is less.
  4. Document Guarantees or Matching Funds: If applicable, maintain records of any guarantees or matching funds provided by associated enterprises.
  5. Carry Forward Excess Interest: If interest exceeds the cap, carry it forward for up to eight years, subject to the same 30% EBITDA limit in future years.

Examples: ​

  1. Scenario 1:

    • An Indian company has an EBITDA of ₹10 crore and pays ₹4 crore in interest to a non-resident associated enterprise.
    • The deductible interest is capped at 30% of EBITDA (₹3 crore). The excess ₹1 crore is not deductible in the current year but can be carried forward for up to eight years.

  2. Scenario 2:

    • A foreign company’s permanent establishment in India pays ₹1.5 crore in interest to a non-resident associated enterprise.
    • Since the interest exceeds ₹1 crore, only ₹1 crore is deductible. The remaining ₹50 lakh is not deductible unless it falls within the 30% EBITDA cap.

  3. Scenario 3:

    • An Indian bank pays ₹5 crore in interest to a non-resident associated enterprise.
    • Since banks are exempt from this section, the entire ₹5 crore is deductible.

This section aims to balance the need for legitimate business financing with the prevention of tax base erosion through excessive interest deductions, particularly in cross-border transactions.