Budget 2019| Tax boost needed to augment debt investments

Currently, the concessional tax regime provides 5 percent tax withholding on interest payments on specified borrowings as per sections 194LB, 194LC and 194LD, subject to certain conditions.

Section 194LB provides a concessional tax withholding of 5 percent on interest payments to non-residents by an infrastructure debt fund.

Section 194LC provides a concessional tax withholding of 5 percent on interest payments pursuant to foreign currency loans and long term bonds (foreign currency or INR denominated) issued to non-residents. The concessional tax rate will apply on interest payments pursuant to monies borrowed or bonds issued before July 1, 2020.  The concessional tax withholding is also subject to the interest rate cap as prescribed.

Section 194LD provides a concessional tax withholding of 5 percent on interest payable before July 1, 2020, by an Indian company to FPIs and qualified foreign investors in respect of investments made in rupee-denominated bonds and government securities. The concessional tax withholding is also subject to the interest rate cap as prescribed.

The government and RBI should consider to completely exempt the interest payments on specified borrowings from withholding tax to attract more investments and reduce the overall cost of borrowing, since in many cases the taxes are borne by the Indian borrower or issuer. The loss of revenue by exempting the withholding tax would be compensated by the benefits of augmentation of foreign exchange inflow into the country, low cost foreign borrowings for Indian companies particularly for the infrastructure sector and resolve the issue of widening current account deficit.

Companies engaged in the business of operating and developing airport have specifically asked the government to exempt from tax, the interest payments to non-residents on bonds issued for more than 5 years of maturity, to reduce overall funding cost as the taxes are grossed-up and borne by them.

The government should at least consider extending the aforesaid sunset clauses to enable Indian businesses to continue to access low cost foreign funds. In the absence of a concessional tax regime, the Indian borrower or issuer will be subject to tax withholding at 20 percent under the domestic tax law which may be reduced to 7.5 percent, 10 percent or 15 percent under the applicable tax treaty.

A clarification on eligibility of an FPI to claim concessional withholding tax rate of 5 percent on interest from an infrastructure debt fund as per section 194LB, read with section 115A, would be useful if the sunset clause under section 194LD is not extended further.

While sections 194LC and 194LD refer to bonds, the underlying presumption is that the provisions are applicable to debentures as well and the intention is not to strictly restrict its applicability only to bonds. A clarification in this regard will make it consistent with the intention.

The Finance Act of 2017 extended the concessional tax rate of 5 percent under section 194LC to rupee-denominated bonds with the intention to accelerate issuance of rupee-denominated bonds outside India (masala bonds). However, the provisions as introduced in section 194LC is broad to cover all rupee-denominated bonds whether issued within or outside India. A clarification in this regard should address the ambiguity.

Income characterisation of premium on redemption of bonds and debentures is important to test the interest rate cap condition. Even if such a premium were to be characterised as interest, one needs to analyse if the same will be amortised and added to the regular interest from inception, to test interest rate cap conditions. It will also need to be seen if such premium will be considered as interest and tested only at the time of redemption during the actual payment.

Overall, the Indian debt market is still evolving and the clarifications discussed above would provide more certainty to both, Indian borrowers and foreign investors and lenders.

Jimit Shah is Director and Pooja Dhokad is Manager, Deloitte India. Views are personal.