Thin Capitalization – Part III

In part I & II of this article, we tried to analyzed and understood provision of sub-section (1) and proviso of sub-section (1) of section 94B. In this part, we try to analyze and understand remaining portion of section 94B as below,

94B. (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.

• Analysis:

Let’s put it by simple example,

Particulars		(Rs. In Cr)
1st	Amount of total Interest paid or payable	(A)	100
	Earnings before interest, taxes, depreciation and amortization (EBITDA)	(B)	200
	Interest paid or payable in excess of 30% of EBITDA [ A – (30% of B) ]	(C)	40
2nd	Interest paid or payable to associated enterprise	(D)	70
	Excess interest u/s 94B(2) [Lower of C or D]	(E)	40

• In 1st limb – an amount of total interest paid or payable and EBITDA has to be taken at enterprise level. Meaning thereby, amount of total interest paid or payable includes interest in respect of debt issued by associated enterprise as well as non-associated enterprise whether resident or non-resident.
• In 2nd limb – Interest paid or payable to associated enterprise. It has not specified whether associated enterprise has to be resident or non-resident.
• As per implementation guide w.r.t notification No 33/2018 dated 20/07/2018 w.e.f 20/08/2018 issued by ICAI for the purpose of reporting under clause 30B of form 3CD, Sec 94B(2) controlled by Sec 94B(1) as sub-section (2) is for the purpose of sub-section (1). Hence, excess interest under sub-section (2) restricted to interest in respect of NR-AE as sub-section (1) talk about NR-AE interest only.
• If such interpretation is to be adopted then, 2nd limb become redundant as in no case 2nd limb be lower and in every case interest paid or payable to NR-AE allowed up to 30% of EBITDA.
• Further, If EBITDA is negative, whole such interest paid or payable to NR-AE will be disallowed.

94B. (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.

• Analysis:
  • An Indian company which is engaged in business of banking or insurance,
  • PE of foreign company which is engaged in business of banking or insurance

Sec 94B will not apply.

94B. (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.

• Analysis:

Let’s put it by simple example,

Particulars		(Rs In Cr.)
		Year 1	Year 2
Amount of total Interest paid or payable	(A)	100	60
Earnings before interest, taxes, depreciation and amortization (EBITDA)	(B)	200	240
Interest paid or payable in excess of 30% of EBITDA [A – (30% of B)]	(C)	40	–
Interest paid or payable to associated enterprise	(D)	70	30
Excess interest u/s 94B(2) [Lower of C or D]	(E)	40	–
Interest disallowed u/s 94B [ E ] under head PGBP	(F)	40	–
Claimed of Brought Forward interest	(G)	–	12*
Interest not deducted under head PGBP and carried forward for next 8 assessment years	(H)	40	28

*[(240*30%)-60] subject to brought forward interest.

• Where interest expenditure has been disallowed u/s 94B then amount of disallowed interest,
  • Shall be carried forward to next 8 assessment years, and
  • Shall be allowed as deduction under the head PGBP to the extent of maximum allowable interest expenditure in accordance with sub-section (2).
• The word used is deduction under the head PGBP that means due to claim of brought forward interest expenditure, to the extent of maximum allowable interest, may result into loss under the head PGBP.
• Further, the term maximum allowable interest has not been defined anywhere in section. Also sub-section (2) define the term excess interest. Sub-section (2) restrict interest deduction to lower of 30% of EBITDA or paid or payable to associated enterprise.
• Further, legislative intent suggest that entity can claim interest expenditure payable to associated enterprise up to 30% of EBITDA. Hence, interest paid or payable in current year plus brought forward interest expenditure should not exceeds 30% of EBITDA.
• In a case where, during the current year there is disallowance u/s 94B i.e. interest paid or payable in current year exceeds 30% of EBITDA, then there could not arise question of deduction of brought forward interest expenditure.
• It is worthwhile to note that sub-section (1) used the word interest or similar nature expenses while determining threshold of Rs 1 Cr. Sub-section (2), determine excess interest, in both limbs and sub-section (4) interest to be carried forward used the word interest only.

94B. (5) For the purposes of this section, the expressions—

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

(ii) “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“;

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

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Thin Capitalization – Part II