News › Weekly Alert Article

HC Ruling on Interest Payment on Debt Capital

10 Sep 2012

The Bombay High Court (HC) has recently delivered an important ruling on the allowability of interest expense in the hands of the taxpayer in the absence of specific thin capitalisation rules (TC rules). The HC recognised that in the absence of TC rules, re-characterisation of debt into equity capital is not permissible. Taxand India explores the case which led to the ruling.

Besix Kier Dabhol SA is a company registered under the laws of Belgium. It was constructing a fuel jetty near Dabhol in India, through a Branch Office (BO). The BO was duly registered with the Reserve Bank of India (RBI). By virtue of the BO, a Permanent Establishment (PE) of the taxpayer was constituted in India and accordingly, it was assessable to tax in respect of the profits attributable to such PE in India.

During that financial year, the taxpayer had paid an amount of Rs 57.3 million as interest on the loans borrowed from its shareholders, and since the same was in respect of the income attributable to the PE, a deduction in respect of the interest was claimed in computing the income of the taxpayer's PE in India.

The Revenue Authorities (RA) had sought for the re-characterisation of debt into equity by arguing that the financial structure was actually equity capital in the guise of debt. However a Tribunal rejected the RA's contention and held that it would not be possible to apply TC rules and disallow the interest expense.

Being aggrieved by the order of the Tribunal, the RA had preferred an appeal before the HC. The HC stated that there was no question of law involved on this aspect and dismissed this appeal with regard to the question.

Discover more: Bombay HC rules on interest payment on debt capital

Your Taxand contact for further queries is:

Mukesh Butani
T. +91 124 339 5010

Taxand's Take

This is an important judgment in terms of multinationals having a relatively leveraged capital structure, where a substantial part of the funding is made by shareholders in the form of debt. The HC has affirmed the principle that TC rules cannot be enforced on taxpayers when there are no specific provisions under the Income Act. However, it will be interesting to see if this is amended in the future.

Taxand's Take Author