SECTION 94B – APPLICABILITY TO RESIDENT COMPANIES

            Are the provisions of section 94B of the Income Tax Act, 1961 (“the Act”) applicable to the interest paid on loans taken by resident entities?

2.         Section 94B of the Act, limits the deduction of interest to 30 percent of the earnings before interest, taxes, depreciation and amortization (“EBIDTA”) of the borrowers in the previous year in respect of interest paid on loans given by an Associated Enterprise (AE) or guaranteed by such AE.

3.         Provisions of section 94B read as under:-

            ‘94B. (1)  Notwithstanding anything contained in this Act, where an Indian company, or a permanent establishment of a foreign company in India, being the borrower, incurs any expenditure by way of interest or of similar nature exceeding one crore rupees, which is deductible in computing income chargeable under the head “Profits and gains of business or profession” in respect of any debt issued by a non-resident, being an associated enterprise of such borrower, the interest shall not be deductible in computation of income under the said head to the extent that it arises from excess interest, as specified in sub-section (2) :

Provided that where the debt is issued by a lender which is not associated 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.

(1A)  Nothing contained in sub-station (1) shall apply to interest paid in respect of a debt issued by a lender which is a permanent establishment in India of a non-resident, being a person engaged in the business of banking.

(2)  For the purposes of sub-section (1), the excess interest shall mean an amount of total interest paid or payable in excess of thirty per cent of earnings before interest, taxes, depreciation and amortisation of the borrower in the previous year or interest paid or payable to associated enterprises for that previous year, whichever is less.

(3)  Nothing contained in sub-section (1) shall apply to an Indian company or a permanent establishment of a foreign company which is engaged in the business of banking or insurance.

(4)    Where for any assessment year, the interest expenditure is not wholly deducted against income under the head “Profits and gains of business or profession”, so much of the interest expenditure as has not been so deducted, shall be carried forward to the following assessment year or assessment years, and it shall be allowed as a deduction against the profits and gains, if any, of any business or profession carried on by it and assessable for that assessment year to the extent of maximum allowable interest expenditure in accordance with sub-section (2):

Provided that no interest expenditure shall be carried forward under this sub-section for more than eight assessment years immediately succeeding the assessment year for which the excess interest expenditure was first computed.

            (5)  For the purposes of this section, the expressions –

• “associated enterprise” shall have the meaning assigned to it in sub-section (1) and sub-section (2) of section 92A;

• “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”;

• “permanent establishment” includes a fixed place of business through which the business of the enterprise is wholly or partly carried on.’

(Emphasis supplied)

• It may be pointed out that section 94B was brought on the statute by the Finance Act, 2017 with effect from Assessment Year 2018-19.  However, sub-section (1A) was brought on under the statute by the Finance Act, 2020 with effect from Assessment Year 2021-22.

• At the outset, it will be noted that, by sub-section (3) of section 94B, the section has been made inapplicable to an Indian company or a Permanent Establishment (“PE”) of a foreign company which is engaged in the business of banking.  Thus, limitation of interest deduction in the case of Indian banks does not arise.  It may also be noticed that a PE of a foreign bank is not subject to the rigours of section 94B.  This sub-section, however, deals with the treatment of interest paid by such banks.  Thus, interest paid to banks by entities not carrying on banking business may be covered by the provisions of section 94B of the Act.  The inclusion of a PE of a foreign entity carrying on the business of banking would also need to be noted, as this has a bearing on the subsequent introduction of sub-section 1(A) of section 94B – which will be discussed infra.

• At the second outset, may be pointed out the constitutionality of the section was challenged before the Madras High Court in Siemens Gamesa Renewable Power Pvt.Ltd., vs UOI, being WP No.19436/2018.  The High Court ruled in favour of the constitutionality of the enactment of section 94B.

• Before interpreting the provisions of section 94B of the Act, it would be necessary to understand the reasons for the provisions of section 94B being incorporated in the Act.  It may be noted that there is no reference by the Finance Minister in her Budget Speech either to the reason for the introduction of Section 94B in the Act or to the addition of sub-section (1A) in Section 94B of the Act when she introduced the provisions in the Finance Bills 2017 and 2020, respectively, in the Parliament.  Therefore, one would have to look at the Explanatory Memorandums to the respective Finance Bills to understand the reasons for the introduction of section 94B and the addition of sub-section (1A) thereto.  These Memorandums read as under :-

A.  To the Finance Bill 2017 – “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.

Under the initiative of the G-20 countries, the Organization for Economic Co-operation and Development (OECD) in its Base Erosion and Profit Shifting (BEPS) project had taken up the issue of base erosion and profit shifting by way of excess interest deductions by the MNEs in Action plan 4.  The OECD has recommended several measures in its final report to address this issue.

In view of the above, it is proposed to insert a new section 94B, 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.

The provision shall be applicable to an Indian company, or a permanent establishment of a foreign company being the borrower who pays interest in respect of any form of debt issued to a non-resident or to a permanent establishment of a non-resident and who is an ‘associated enterprise’ of the borrower.  Further, the debt shall be deemed to be treated as issued by an associated enterprise where it provides an implicit or explicit guarantee to the lender or deposits a corresponding and matching amount of funds with the lender.

The provisions shall allow for carry forward of disallowed interest expense 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.

In order to target only large interest payments, it is proposed to provide for a threshold of interest expenditure of one crore rupees exceeding which the provision would be applicable.

It is further proposed to exclude Banks and Insurance business from the ambit of the said provisions keeping in view of special nature of these businesses.

This amendment will take effect from 1^st April 2018 and will, accordingly, apply in relation to the assessment year 2018-19 and subsequent years.             

                                                                                                                       (Clause 43)”

        (Emphasis supplied)

B.  To the Finance Bill 2020 – “Excluding interest paid or payable to Permanent Establishment of a non-resident Bank for the purpose of disallowance of interest under section 94B.

Section 94B of the Act, inter alia, provides that deductible interest or similar expenses exceeding one crore rupees of an Indian company, or a permanent establishment (PE) of a foreign company, paid to the associated enterprises (AE) shall be restricted to 30 per cent of its earnings before interest, taxes, depreciation and amortisation (EBITDA)

or interest paid or payable to AE, whichever is less.  Further, a loan is deemed to be from an AE, if an AE provides implicit or explicit guarantee in respect of that loan.  AE

for the purposes of this section has the meaning assigned to it in section 92A of the Act.  This section was inserted in the Act through the Finance Act, 2017 in order to implement the measures recommended in final report on Action Plan 4 of the Base Erosion and Profit Shifting (BEPS) project under the aegis of G-2—Organisation of Economic Co-operation and Development (OECD) countries to address the issue of base erosion and profit shifting by way of excess interest deductions.

Representations have been received to carve out interest paid or payable in respect of debt issued by a PE of a non-resident in India, being a person engaged in the business of banking for the reason that as per the existing provisions a branch of the foreign company in India is a non-resident in India.  Further, the definition of the AE in section 92A, inter alia, deems two enterprises to be AE, if during the previous year a loan advanced by one enterprise to the other enterprise is at 50 per cent or more of the book value of the total assets of the other enterprise.  Thus, the interest paid or payable in respect of loan from the branch of a foreign bank may attract provisions of interest limitation provided for under this section.

It is, therefore, proposed to amend section 94B of the Act so as to provide that provisions of interest limitation would not apply to interest paid in respect of a debt issued by a lender which is a PE of a non-resident, being a person engaged in the business of banking, in India.

This amendment will take effect from 1^st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-22 and subsequent assessment years.

                                                                                                                        Clause 46”

• In this regard, by the Circular No. 2/2018, dated 15.02.2018, issued by CBDT, vide paras 46.1, 46.2 and 46.3, the following has been set out:

“46.     Limitation of Interest deduction in certain cases.

46.1.    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 debit in a company, and thus higher 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 Enterprises (MNEs) are often able to structure their financing

arrangements to maximize these benefits.  For this reason, tax administrations of several countries have introduced 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.

46.2.    Under the initiative of the G-20 countries, OECD in its Base Erosion and Profit Shifting (BEPS) project had taken up the issue of base erosion and profit shifting by way of excess interest deductions by the MNEs in Action plan 4 and has recommended several measures in its final report to address this issue.

46.3.    In view of the above, a new section 94B has been inserted in the Income-tax Act so as to provide that interest expenses claimed by an entity to tis 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”

Virtually, this circular has reiterated what has been mentioned in the Explanatory Memorandum to the Finance Bill, 2017.

• Sub-section (1) of Section 94B is very clear in that it is speaking of any debt issued by a non-resident, being an associated enterprises of said borrower.  As per main provisions of the sub-section (1) of section 94B, therefore, it is only such direct debt from the AE which would be subject to the restriction of the interest allowability to 30 per cent of EBITDA.

1. One can understand the purport of the main sub-section (1) of Section 94B.  In this regard, it will be interesting to note the following words in the Explanatory Memorandum to the Finance Bill 2017. 

“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.”

The purport seems to be that the funding by the AE to companies by way of loan (as compared to equity) should be reasonable and not excessive.  It is not the rate at which the interest is charged but the amount of outgoing which is considered – by the Legislature and the BEPS Action Plan 4 – as reasonable.  That reasonability has been fixed at 30 per cent of EBIDTA – above which the limitation and disallowance of interest would come to play.  Nor is it the currency in which the payment is made; or whether in India or outside India.  So far, so good! 

1. However, the proviso to sub-section (1) puts the cat amongst the pigeons.  This is because in the proviso even though the debt is issued by a lender, who is not an AE, when the AE guarantees the debt, the interest thereon becomes subject to the restrictions provided in section 94B of the Act.  There is a presumption that, because of the guarantee, there is a higher interest charge in the accounts of the company, by the AE providing more loans and less equity. 

1. What should be the interpretation of the proviso?  Though it has not been mentioned in the proviso, under the main sub-section (1) of section 94B, the debt should be issued by a lender, which is a non-resident.  After all the proviso is a proviso and should, as far as possible, be read in conjunction with the main provision.  The main sub-section (1) of section 94B is applicable to any debt by a non-resident, being an associated enterprise. This should be interpreted as “debt by a non-resident and being an associated enterprise.” If either the lender or the AE is not a non-resident the provisions of section 94B(1) would not be applicable.  Therefore, it is only if the debt is issued by a non-resident that Section 94B(1) would come into play – with the added condition of it being  by the AE, being a non-resident.  By the proviso, even a guarantee given by the AE to the lender (who is not an AE), would make the interest restriction applicable to the company.  But is it any lender or should the proviso be applicable in respect of only a non-resident lender in view of the provisions of section 94B(1)?  In my opinion, the lender should be a non-resident, i.e., the debt should be issued by a

1.  non-resident lender and guaranteed by the non-resident AE.  So, if the debt is issued by an Indian entity, which is a resident, though guaranteed by an AE which is non-

resident, such lending would not be covered by the restrictive provisions of 94B(1) and the proviso for limitation on the allowability of interest.

1. This interpretation is now strengthened by the provisions of sub-section (1A) of section 94B of the Act.  The reason that sub-section (1A) was brought on the statute was, as mentioned in the Explanatory Memorandum,  that a PE of a non-resident would take the status of “non-resident” and any lending by the PE to a company in India would get covered by the interest deduction limitation under section 94B of the Act, if the said loan given by the PE in India is also guaranteed by a non-resident AE of the company in India, primarily because the PE of a non-resident would continue to have the status of non-resident.  In order to not bring such PEs which are non-residents, within the purview of limitation of interest deduction, sub-section (1A) of section 94B has been enacted, virtually categorising the PE a resident so that the disallowability would not need to take place.  This sub-section, therefore, indirectly makes it clear that, otherwise, only if the lender is a non-resident would the interest limitation provisions of section 94B apply.  Of course, the non-resident PE should be in the business of banking.

1. Therefore, this sub-section (1A) makes it clear that the legislature did not want loans by residents to be covered by the restrictive provisions of section 94B.  This is the only way in which these provisions can be read harmoniously. This would imply that the proviso to sub-section (1) of section 94B  should have some words inserted in it and the proviso would then look as under :-

“Provided that where the debt is issued by a lender, being a non-resident, which is not associated, 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”.

                                                                                       (Inserted words in Italics)

1. There are ample case law to support the theory that a Court can interpret the Section by adding in certain requisite words.  This is what the Learned Author and Jurist, Shri N.A. Palkhivala says in his book “The Law and Practice of Income Tax, 10^th Edition (2014), at page 12, which is reproduced as under :-

“Though ordinarily no words can be added or read into an Act unless it is absolutely necessary to do so, departure from this rule is legitimate in such cases where literal construction may result in depriving certain existing words of all the meaning or to avoid any part of the statue becoming meaningless or otiose.  Thus, where a literal construction would defeat the obvious intention of the legislation and produce a wholly unreasonable or manifestly unjust result, the court must follow the rule of reasonable construction or modify the language of the statute or even ‘do some violence to the words’ to achieve that obvious intention and produce a rational construction.  The intention of the legislature has to be gathered from the language used in the statute, which means that attention should be paid to what has been said as also to what has not been said.”

Inter-alia, the following case laws have been relied upon for the aforementioned propositions.

• Luke v IRC, 54 ITR 692 709 (HL)
• CIT v National Taj Traders, 121 ITR 535, 542 (SC)
• K.P. Varghese v ITO, 131 ITR 597, 606 (SC)
• CIT v J.H. Gotla, 156 ITR 323, 339 (SC)
• Keshavji Ravji & Co. v CIT, 183 ITR 1 (SC)
• Goodyear India Ltd v State of Haryana, 188 ITR 402, 440 (SC)
• Bajaj Tempo Ltd. v CIT, 196 ITR 188, 194, 197(SC)
• CWS (India) Ltd v CIT, 208 ITR 649(SC)
• Padmasundara Rao v State of TN, 255 ITR 147 (SC)
• CIT v Hindustan Bulk Carriers, 259 ITR 449, 464-65(SC)
• Jamshedpur Motor Accessories v UOI, 189 ITR 70

(SLP rejected 191 ITR 8)

• CIT v B.M. Bhatacharjee, 118 ITR 461, 479-80(SC)

1. Therefore, in my view, this proviso to sub-section (1) of section 94B should be interpreted as applicable in respect of a non-resident lender only, and not in respect of a resident lender, even though guaranteed by the non-resident AE.

1. To sum up :

1. Sub-section (1) of section 94B should be interpreted as if both the lender and the AE are non-residents;

1. The proviso to section 94B(1) should be interpreted as if the lender is a non-resident lender in order to bring it in tandem with the main provisions of sub-section (1) of section 94B;

1. Sub-section (1A) of section 94B takes even a PE of a non-resident engaged in the business of banking outside the purview of the interest limitation provisions thereby virtually making it clear that other non-residents fall within the purview of section 94B and in effect makes it clear that loans by resident lenders are outside the purview of section 94B of the Act. This also gives grist to the view that it is only lendings by non-residents  which would be covered by the main provisions of section 94B (1) read with its proviso;

1. The court is competent to provide requisite words to give a harmonious view to the provisions of section 94B of the Act. And hence the words “being a non-resident” can be added into the proviso to sub-section (1) of section 94B of the Act at the appropriate place, as set out, supra.

                                                                                                                        Ashok Rao

Date :   7^th July, 2022.