Tax on corporate lending and bond issues in India: overview
A Q&A guide to tax on finance transactions in India.
This Q&A provides a high level overview of finance tax in India and focuses on corporate lending and borrowing (including withholding tax requirements), bond issues, plant and machinery leasing, taxation of the borrower and lender when restructuring debt, securitisations, the Foreign Account Tax Compliance Act (FATCA) and bank levies.
To compare answers across multiple jurisdictions, visit the Tax on Corporate Lending and Bond Issues: Country Q&A tool.
The Q&A is part of the global guide to tax on transactions. For a full list of jurisdictional Q&As visit www.practicallaw.com/taxontransactions-guide.
The Constitution delegates power to levy tax to central government and state governments. Local authorities, such as municipalities, levy some local taxes under powers given to them by state governments.
The main authorities responsible for tax on corporate transactions are:
The Central Board of Direct Taxes (CBDT), part of the Department of Revenue in the Ministry of Finance. CBDT supports policy and planning for (federal) direct taxes. It also administers direct tax.
The Central Board of Excise and Customs (CBEC). CBEC is the national agency that administers customs, central excise and service tax (federal indirect taxes).
State governments, which levy and collect state taxes, for example, tax on the sale of goods and octroi (a form of local customs tax).
Municipalities, responsible for levying and collecting taxes at local level, for example, municipal tax on services and real estate tax.
Pre-completion tax clearances
Circumstances for obtaining clearance
There are a number of ways to obtain advance clearance and guidance from the authorities depending on the type of tax:
The Authority for Advance Rulings (AAR), part of the Ministry of Finance, provides rulings on the income tax consequences of transactions entered into by non-residents and other eligible taxpayers. The AAR rulings bind both the applicant and the Department of Revenue.
The Authority for Advance Rulings (Central Excise, Customs and Service Tax) (AAR(CECST)) provides advance rulings on indirect tax matters.
A taxpayer can seek an Advance Pricing Agreement (APA) to determine acceptable transfer prices in advance of a transaction. An APA is a written agreement between a taxpayer and the tax authorities in respect of specified related party transactions. The Department of Revenue cannot challenge transfer prices after it has agreed to an APA.
Under safe harbour rules, the tax authorities accept the transfer price declared by the taxpayer without detailed scrutiny. Safe harbour rules apply in certain sectors only. The rules specify an appropriate/acceptable margin for the transaction. If the margin is achieved, no transfer pricing adjustment will be made by the Revenue. The CBDT makes safe harbour rules under legislation intended to reduce the increasing number of transfer pricing audits and litigation (section 92CB, Income Tax Act 1961).
Safe harbour rules do not apply to an international transaction with an associated enterprise located in:
any notified country or territory; or
in a no tax or low tax country or territory.
The Assessing Officer has the power to issue a withholding tax certificate authorising lower or no deduction of tax where the rate of tax deduction to be applied on certain payments is uncertain. The Assessing Officer usually issues certificates to the person receiving the payment, but they may be issued to the deductor in certain cases.
Withholding tax certificates given by the assessing officer are not a final determination of the payee's tax liability. Certificates determine the liability of the payer to withhold tax.
Mandatory or optional clearance?
It is not mandatory to obtain tax clearance before entering into any financial transaction.
Procedure for obtaining clearance
AAR. A non-resident can apply for an advance ruling using Form 34C and a resident can apply for an advance ruling using Form 34D. The applicant must submit four copies of the application to the AAR with the application fee (INR10,000 or as prescribed by the AAR). The Department of Revenue is also given an opportunity to provide its views on the questions raised in the application.
Generally, the AAR will provide its ruling after hearing both the applicant and the Department of Revenue within six to eight month from the date of receiving the application.
APA. The procedure for entering into an Advance Pricing Agreement (APA) involves four phases: pre-filing phase; formal submission phase; negotiation phase; and the finalisation phase. The phases are described below:
Pre-filing phase. The process is started by conducting a pre-filing consultation meeting (which can be anonymous if desired) to determine the transfer pricing issues to be covered/agreed under the agreement. Whether or not the international transaction in question is suitable to be subject to an APA is also determined at this meeting. No fee is due at this phase.
Formal submission phase. If the taxpayer wishes to apply for an APA after the pre-filing meeting, he can make the application in the prescribed format. The applicant must complete the requested information correctly, and should also describe the critical assumptions. No material change should be made to these critical assumptions, as such a change could result in the revision or termination of the APA. At this phase, the process is not in the public domain and can be anonymous, if desired. The applicant must pay an APA filing fee at this stage.
Negotiation phase. After the application is accepted by the tax authorities, the APA team will conduct a meeting with the applicant to make necessary inquiries. A draft report will be prepared by the team, which will be submitted to the Competent Authority in India (for a unilateral/multilateral APA) or the Director General of Income Tax (International Tax and Transfer Pricing) (for a unilateral APA).
Finalisation phase. In the last phase, comments on the draft report are considered and the APA is finalised and given effect. The taxpayer must prepare and submit an Annual Compliance Report (ACR) for each year that the APA remains valid, to detail the actual result for that year and establish compliance with the terms of the APA.
Withholding certificate. Generally, a withholding certificate is sought for the following purposes:
To determine the character and nature of payment and the applicable withholding rate on that payment.
To determine the portion of income that will be subject to withholding tax.
The tax officer will generally ascertain the genuineness of the financial transaction before issuing a withholding tax certificate.
The procedure for obtaining a withholding tax certificate is as follows:
Submission of information and the application in the prescribed format.
The completed form must be signed and delivered to the jurisdictional assessing officer.
The assessing officer will hear the applicant, if necessary, and will issue an appropriate certificate on the basis of the application.
The taxpayer can elect to be represented by an authorised representative.
The procedure usually takes a few weeks from the date of filing the application before the jurisdictional assessing officer.
Disclosure of finance transactions
Circumstances where disclosure is required
There is no requirement to disclose a financial transaction before it is made under the Indian Income Tax Laws.
However, when tax returns are filed every financial year, an Indian taxpayer must disclose the effect of a financial transaction on their taxable income.
Along with the tax returns, a taxpayer must also complete the prescribed forms (such as Form 3CA, Form 3CB, Form 3CD and Form 3CEB) as part of his annual tax return filing under the Indian Income Tax Laws. These forms require certain information to be disclosed. A taxpayer must also provide documents when the same are required by the tax authorities during the course of auditing the tax return.
Manner and timing of disclosure
The disclosure of a financial transaction is made in a taxpayer's annual tax return.
Taxes on corporate lending/borrowing
Taxes potentially chargeable on amounts receivable
Corporate income tax
Key characteristics. Interest means a consideration or a fee received for money lent. It includes any interest payable in any manner in respect of moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charges in respect of moneys borrowed or debt incurred.
Interest income is taxed in the hands of recipient of income in the form of interest on capital (creditor/lender). The debtor/borrower is eligible for a tax deduction in respect of the interest amount paid to the lender if that interest expenditure is incurred wholly and exclusively for the purposes of his business.
Where a lender is engaged in the business of lending money, the income derived from that business will be taxable as income from business. However, if a lender is not engaged in the lending business, interest income is taxed under the residuary head "income from other sources".
Calculation of tax. An Indian resident company is taxed in India on its worldwide income. Interest income derived from receivables, loans and any other debt instrument is typically included as taxable income and is subject to corporate tax at the applicable rates.
Triggering event. The receipt of interest payable in respect of moneys borrowed or debt incurred in any manner (including a deposit, claim or other similar right or obligation) triggers the tax in the hands of the recipient receiving interest income.
Applicable rate(s). The following are the applicable tax rates for financial year 2014-2015:
Taxable income of a domestic company up to INR10 million: 30.90%.
Taxable income of a domestic company exceeding INR10 million but less than INR100 million: 32.45%.
Taxable income of a domestic company exceeding INR100 million: 33.99%.
Tax reliefs available for borrowing costs
Key characteristics. Any expenditure incurred by an Indian entity in relation to loans taken for general business purposes is deductible. The interest on a loan can be deducted by the borrower in the year it is accrued. The following considerations are relevant in this regard:
The purpose for which the loan has been taken.
The interest income earned on the transaction.
The loan is taken for a bona fide business purpose.
Whether the transaction is between related parties.
A borrowing cost incurred wholly and exclusively for the purposes of the business of the company is allowable as business expenditure incurred by the company provided the expenditure is not in the nature of either:
However, interest paid on account of a loan taken for a capital purpose is not allowed as a revenue deduction under the Indian income tax laws. Depending on the facts, the interest may be capitalised along with the cost of the asset and the aggregate cost base may be eligible for depreciation. No interest rates are specified under the Indian income tax laws.
Calculation of relief. Where loan expenses are deductible, the entire amount incurred can be deducted for corporate income tax purposes.
Triggering event. Interest paid on capital borrowed for a business purpose is treated as an allowable expenditure under the Indian income tax laws. However, any interest which is paid for the capital borrowed for the acquisition of an asset, or for the extension of an existing business or profession (whether capitalised in the books of account or not) is generally not allowed as a revenue deduction. The triggering event is the accrual of interest or its payment, whichever is earlier.
Applicable rate(s). No rates are specified under the Indian income tax laws.
Tax payable on the transfer of debt
Key characteristics. Stamp duty is payable when there is a transfer of a debt as a marketable debenture.
Calculation of tax. Stamp duty in India differs from state to state based on relevant state stamp law.
Triggering event. Stamp duty is triggered when there is a transfer of a debt as a marketable debenture.
Liable party/parties. Stamp duty is payable by the person who is executing the transfer instrument.
Applicable rate(s). The amount of the stamp duty payable depends on the specific state stamp law.
When withholding tax applies
Interest paid by a resident Indian company to another resident company under a loan will be subject to withholding tax if the interest paid exceeds INR5,000.
Interest paid by a resident Indian company to a non-resident company under a loan will be subject to withholding tax.
Applicable rate(s) of withholding tax
The withholding tax rate for a resident is 10% (plus a surcharge and cess, as applicable).
The withholding tax rate for a non-resident varies from 5% to 40% (plus a surcharge and cess, as applicable).
Exemptions from withholding tax
No exemptions from withholding tax are available under the Indian income tax laws.
For a comparative summary of withholding tax on interest, see table, Withholding tax on interest on corporate debt, in this multi-jurisdictional guide.
Consideration paid by a borrower to a guarantor for procuring the guarantee is generally tax deductible, provided such payments are incurred wholly and exclusively for business purposes.
Payments made by a guarantor to fulfil a borrower's default are also usually tax deductible as expenses incurred in the course of a business, provided that both:
The granting of the guarantee was performed in the company's interest.
The commercial substance of the guarantee can be established before the tax authorities.
A guarantee fee will be subject to withholding tax, similar to interest, at the rate of 10% (plus a surcharge and cess, as applicable) under Indian income tax laws.
Taxes payable on the issue and/or transfer of a bond
Transfer of bonds and income tax
Key characteristics. The definition of "income" is wide enough to include within its scope "any capital gains chargeable under the Indian income tax laws". Profits or gains arising from the transfer of a capital asset are chargeable to tax as income under the head "capital gains". Therefore, a capital receipt received as a result of a transfer of a capital asset (for example, a bond) can be covered within the scope of income tax.
A transfer of bonds will fall within the ambit of a "transfer" under the Indian income tax laws and may therefore be liable to tax.
However, under the Indian income tax laws certain transactions are not regarded as a "transfer". The conversions of bonds into shares, or the redemption of bonds into shares, are transactions that are not regarded as a "transfer" under the Indian income tax laws and will not be subject to any income tax.
Calculation of tax. The amount received on account of a transfer of a capital asset will be subject to income tax under the head "capital gains" based on the duration for which the bonds were held (that is, long-term or short-term).
Triggering event. The transfer of a capital asset which results in a gain will trigger the tax liability.
Liable party/parties. Capital gains will be subject to tax in the hands of the seller/transferor of the capital assets.
Applicable rate(s). The applicable rate of taxation depends on:
The time period for which the bonds were held.
Whether they were considered a "short-term" or "long term" capital asset at the time of the sale.
Whether they were listed or unlisted bonds.
Accordingly, the shares are divided in two parts:
Long-term assets. A share is a long-term capital asset if is held for more than 12 months immediately before the date of transfer.
Short-term assets. A share is a short-term capital asset if it is held for less than 12 months immediately before the date of transfer.
The rate of capital gains tax also depends on whether securities transactions tax (STT) has been paid on the transaction.
Capital gains tax where STT is payable. If STT has been paid:
There is no capital gains tax on long-term capital gains derived from the:
transfer of equity shares or units of an equity-oriented fund on a recognised stock exchange in India;
transfer of units of an equity-oriented fund to a mutual fund; or
sale of unlisted equity shares included in an initial public offer.
Short-term capital gains are taxable at a reduced rate of 15% plus the surcharge, as applicable, and cess, if they are derived from the:
transfer of units of an equity-oriented fund to a mutual fund; or
sale of unlisted equity shares included in an initial public offer.
Capital gains tax where no STT is payable. For sales of shares and units of mutual funds and for capital gains derived from the transfer of a capital asset that is not a specified security, the following are the capital gains tax rates:
short-term capital gains rate: 30%;
long-term capital gains rate: 20%.
short-term capital gains rate: 30%;
long-term capital gains rate: 10%.
Non-residents other than FIIs:
short-term capital gains rate: 40%;
long-term capital gains rate: 20% (from 2012-2013, gains from the transfer of unlisted securities are taxable at 10%, though calculations cannot take currency fluctuations or inflation into account).
The tax is also subject to a surcharge and cess, as applicable.
Key characteristics. Stamp duty is payable by a company which issues bonds under the Indian Stamp Act 1899.
Calculation of tax. The rate of stamp duty in India differs from state to state based on the relevant state stamp law.
Triggering event. When bonds are issued by a company, stamp duty is payable.
Liable party/parties. Stamp duty is payable by the person making or executing the bonds.
Applicable rate(s). Stamp duty in India differs from state to state based on the relevant state stamp law.
Plant and machinery leasing
Claiming capital allowances/tax depreciation
Owner of an asset
Under the Indian income tax laws, only the owner of an asset can claim tax depreciation on that asset.
Depreciation is allowed subject to the following conditions:
Depreciation is available for tangible and intangible assets.
The asset must be owned by the taxpayer who claims the depreciation (wholly or partially owned by the taxpayer for the purpose of claiming the depreciation).
The asset must be used for the purpose of a business or profession carried on by the taxpayer.
In the case of a block of assets, the depreciation must be calculated on the written down value of the block.
A lessee cannot take the benefit of depreciation on any buildings, plant or machinery which is used for the purpose of his business since he does not possess the ownership rights on the leased asset.
Rate of capital allowances/tax depreciation
Depreciation can be claimed on both tangible and intangible assets. The following are the rates of depreciation:
Buildings (other than those used mainly for residential purposes): 10%.
Furniture and fittings (including electrical fittings): 10%.
Machinery and plant: 15%.
Motor cars (not used in the business or hired): 15%.
Know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of a similar nature: 25%.
Lessees not carrying on business in the jurisdiction
Taxation of rentals
Rulings and clearances
Unpaid or deferred interest or capital
Generally, interest is deductible or taxable on an accrued basis for corporate tax purposes. Accordingly, tax treatment in the hands of the borrower and lender will be affected by the non-payment, or deferral of payment, of interest only when the provision or allowance is booked.
If a provision or allowance is booked at the level of the lender (corresponding to the unpaid interest and/or the principal of the loan), it is tax deductible at the level of the lender, under the general requirements and applicable provisions. In particular, the loss covered by the provision must be rendered likely by events existing at the end of the relevant year and the amount must be assessed with sufficient accuracy.
In so far as waiver of unpaid loan and interest is concerned, the Delhi High Court in the case of CIT v Jubilant Securities Pvt Ltd (ITA No 503 of 2010) has decided the question of tax treatment of loans and interest waived by financial institutions. The High Court has, in the context of a waiver of a loan amount, held that taxability will depend upon the purpose for which the loan was taken. The waiver of a loan taken to acquire a capital asset will not result in income eligible to tax. However, the waiver of a loan taken for a trading purpose creates taxable income under the Indian income tax laws.
Debt write-off/release and debt for equity swap
Written off or released (wholly or partly)?
Replaced by shares in the borrower (debt for equity swap)?
The following conditions must be fulfilled in order to make the waiver of the debt tax deductible in the hands of the lender:
The debt must have been made in the ordinary course of business and must not be capital in nature.
The waiver of the debt must be commercial in nature and must be recorded as such in the books of account.
From a borrower's perspective, the consequences of a waiver of a loan will depend on the nature of loan. A waiver of a loan obtained for capital purposes could be considered as a capital receipt which is not taxable in the hands of the borrower. A waiver of any loan taken for general business purposes will be taxable in the hands of the borrower.
The taxability of a loan replaced by shares (debt for equity swap) will depend on the details of the particular transaction. Generally, the issuance of equity in lieu of debt is not considered taxable.
The Indian income tax laws do not contain specific provisions or rules for securitisation transactions. Taxation will depend on the way the documents of the transaction are structured, and how the transaction is characterised by the tax authorities. Income in relation to securitisation transactions can be characterised as one of the following:
Income from a business or profession.
Income by way of interest.
Income from capital gains.
Income from other sources.
Foreign Account Tax Compliance Act (FATCA)
Direct tax code (DTC)
A draft of a new DTC that seeks to replace the current direct tax law was published for comment in March 2014. There is no timeline for its introduction.
General anti-avoidance rules (GAAR)
GAAR are scheduled to come into effect from 1 April 2015. GAAR empowers a tax officer to recharacterise a transaction or ignore its effect for tax purposes, if he believes the transaction has been entered into with the primary objective of obtaining tax benefits. GAAR do not apply:
Where the tax benefit does not exceed INR30 million.
Where the benefit accrues to specified foreign institutional investors.
To any income from a transfer of investments made before 30 August 2010.
GAAR will apply to any arrangement, irrespective of the date on which it was made, if the tax benefit is obtained on or after 1 April 2015. However, there is a discussion that in the ensuing Budget, to be released on 28 February 2015, implementation of GAAR may be deferred.
Goods and services tax (GST)
The latest budget mentions the need to implement goods and services tax (GST). GST is an indirect tax that brings together most of the taxes that are imposed on the majority of goods and services under a single tax. Under the current system, taxes are levied separately on goods and services.
GST is a comprehensive form of tax based on a uniform rate of tax for both goods and services. GST is payable only at the final point of consumption. Recently, the Government introduced a GST Bill in the Parliament, which contains a roadmap for the introduction of GST. Considering that the introduction of GST will require amendment to the Constitution of India, it will be watched closely as to how and when the Government is able to push through the Bill, which requires at least a two-thirds majority in the Parliament, which the Government currently does not have.
Directorate of Income Tax (Public Relations, Printing & Publications, Official Language)
Description. The site of the Directorate of Income Tax (Public Relations, Printing & Publications, Official Language) of the government of India. The site is updated regularly and provides the latest provisions, rules, circulars and notification of income tax laws.
Central Board of Excise and Customs (CBEC)
Description. The Central Board of Excise and Customs (CBEC) is a part of the Department of Revenue under the Ministry of Finance, Government of India. It formulates policies for the levy and collection of customs and central excise duties and service tax, prevention of smuggling and administration of matters relating to customs, central excise, service tax and narcotics. The Board is the administrative authority for its subordinate organisations, including Custom Houses, Central Excise and Service Tax Commissioners and the Central Revenues Control Laboratory.
Atul Dua, Senior Partner
Seth Dua & Associates
Professional qualifications. Member of the Bar Council of Delhi; Chartered Accountant
Areas of practice. Corporate tax; international tax; international trade; dispute resolution.
Non-professional qualifications. Bachelor of Commerce; Bachelor of Laws
Foster's Group, Australia: advice relating to capital gains tax in India on sale of shares of a Mauritian entity and the tax implications of the sale of trademark and other IPR rights outside India.
Jcdecaux Advertising (India) Pvt. Ltd: advice on direct and indirect issues in day to day transactions relating to its India operations, including transactions with Bangalore International Airport Limited.
Audi Ag, Germany: advice to Audi, Germany, an automotive giant on all significant matters relating to its India entry strategy including foreign investment policy matters in relation to wholesale and retail business.
Languages. English, Hindi, Punjabi
Professional associations/memberships. Honorary positions in the Inter Pacific Bar Association; Society of Indian Law Firms and Associated Chambers of Industry and Commerce; Secretary of the Competition Law Bar Association, India.
Contributor to Joint Ventures and Mergers & Acquisitions in India – Legal & Tax Aspects, Butterworths/ LexisNexis.
Presentations at various international conferences and seminars organised by Inter Pacific Bar Association, International Fiscal Association, UIA and Lawasia.
Gautam Chopra, Partner
Seth Dua & Associates
Professional qualifications. ACA; ACS; member of Bar Council of Delhi; Chartered Accountant
Areas of practice. Corporate tax, international tax, transfer pricing, international trade.
Non-professional qualifications. B.Com (Hons) LLB
Advised Nissan group on restructuring their operations in India from a tax perspective.
Advised a large multinational group in the energy sector on structuring their proposed acquisition and business operations in India.
Acted for a large private equity group in relation to their proposed acquisition of an Indian entity in the pharma sector.
Advised Triune Group on their dispute with the revenue in relation to a business acquisition.
Represented a large Indian company before the Tax tribunal in relation to its dispute with the Indian Revenue.
Languages. English, Hindi
Professional associations/memberships. International Fiscal Association; ITAT Bar Association; Bar Council of Delhi; International Bar Association.
GAAR - need for best practices, ASSOCHAM.
Profit attribution to PEs - challenges, IFA India Conference.
Export commission agents - taxability in India, mondaq.com.
Liaison offices - Indian tax exposure.