Section 94B – Limitation on Interest deduction

Topic Covered in this page

Section 94B of the Income Tax Act, 1961, provides that any interest paid/ payable by the assessee to its Associated Enterprise (“AE”) ,  shall not be deductible in computation of income under the head “profit and gains of business or profession” , to the extent such interest  constitutes “excess interest”.

Excess Interest for the purpose of Section 94B shall mean : –

  • Total Interest paid or payable (i.e. total interest paid/ payable to AE and non-AE) in excess of 30% of its earning before interest, taxes, depreciation, and amortization (EBITDA) of the borrower in the PY ; or
  • Interest paid/ payable to AE for that previous year

whichever is less.

APPLICABILITY OF SECTION 94B – PERSON COVERED

Where the borrower is an Indian company,  or a permanent establishment of a foreign company in India, who incurs any expenditure by way of interest or similar nature in respect of any form of debt issued by a non-resident AE of the borrower. However, provision of section 94B shall not be applicable to  an Indian company or permanent establishment of a foreign company which is engaged in the business of banking or Insurance.  AE shall have the same meaning as assigned to it in the provision of Transfer Pricing u/s 92A

However, such provisions   would be applicable only when : –

  1. Interest is deductible in computing income chargeable under the head profit and gains of business and profession
  2. Where expenditure by way of interest or of similar nature exceeds Rs. 1 crore, in respect of any form of debt issued by a non-resident AE of such borrower.

MEANING OF DEBT – SECTION 94B

For the purpose of Section 94B , 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”.

 

INTEREST EXPENSE INCURRED FOR AE AND NON-AE – SECTION 94B

EXAMPLE 1 : –

ParticularsAmount (in crores)
EBITDA of ICO (Borrower)200
30% of EBITDA60
Interest paid to foreign AE10
Interest paid to non-AE70
Total interest expense80
Total interest in excess of 30% of EBITDA (80-60) (A)20
Interest paid to AE (B)10
Lower of A and B10
Interest to be disallowed u/s 94B10

INTEREST EXPENSE INCURRED ONLY FOR AE – SECTION 94B

EXAMPLE 2 : –

ParticularsAmount (in crores)
EBITDA of ICO (Borrower)200
30% of EBITDA60
Interest paid to foreign AE80
Interest paid to non-AE0
Total interest expense80
Total interest in excess of 30% of EBITDA (80-60) (A)20
Interest paid to AE (B)80
Lower of A and B20
Interest to be disallowed u/s 94B20

 

INTEREST EXPENSE INCURRED ONLY FOR NON AE – SECTION 94B

EXAMPLE 3 : –

ParticularsAmount (in crores)
EBITDA of ICO (Borrower)200
30% of EBITDA60
Interest paid to foreign AE0
Interest paid to non-AE90
Total interest expense90
Total interest in excess of 30% of EBITDA (90-60) (A)30
Interest paid to AE (B)0
Lower of A and B0
Interest to be disallowed u/s 94B0

 

DEBT DEEMED TO BE ISSUED BY AE – SECTION 94B

In certain cases, the AE, instead of giving direct debt to the Indian party, may provide certain guarantees, or deposit funds against which such independent party may grant loan to the Indian party. To deal with such situation, it is provided that where the debt is issued by a lender which is not AE , but an associated enterprise either : –

  • provides an implicit or explicit guarantee to such lender or
  • deposits a corresponding and matching amount of funds with the lender,

such debt shall be deemed to have been issued by an associated enterprise.

Provision of section 94B shall not be applicable to  an Indian company or permanent establishment of a foreign company which is engaged in the business of banking or Insurance

 

IMPACT OF SECTION 40(A)(I) DISALLOWANCE ON SECTION 94B

EXAMPLE 4 : –

ParticularsAmount (in crores)
EBITDA of ICO (Borrower)100
30% of EBITDA30
Interest paid to foreign AE 170
Interest paid to foreign AE 210
Total interest expense                                                      (A)80
Disallowance under section 40(a)(i)                               (B)10
Interest deductible                                                          (A-B)70
Total interest in excess of 30% of EBITDA (80-30)50
Interest paid to AE80
Lower of A and B                                                              (C)50
Disallowance u/s 94B (50-10)                                      (C – B)40

 

NOTE : –

Provision of section 94B would be applicable where interest is deductible in computing income chargeable under the head profit and gains of business and profession. In example 4 interest paid to AE 2 of Rs. 10 crore is not deductible due to disallowance under section 40(a)(i). Accordingly such interest of Rs. 10 crore should not be consider for disallowance under section 94B.

Share on whatsapp
Share on facebook
Share on twitter
Share on linkedin
Share on email

Leave a Comment