(First Published on Linkedin)
A recent judgment of the Delhi High Court reaffirms the principles of commercial expediency, highlighting that interest paid on loans borrowed in India and deployed exclusively for foreign subsidiaries/ the business carried outside India is not taxable in India under Section 9(1)(v). This principle, which is critical to structuring global investments, throws open various structuring considerations.
Key Takeaways:
1) Income Tax Act:
– Commercial Expediency Principle: Irrespective of whether the investment is in foreign subsidiaries or Indian subsidiaries, the principle of commercial expedience warrants that the interest expense should qualify as deductible under Section 36(1)(iii) if the investment is for strategic business purposes. This applies irrespective of whether the returns are through dividends in the case where borrowed funds are used for equity investments – the restriction under Section 57(iii) (20% cap on interest deduction for income from other sources) should not apply in the first place if the investment is seen as part of the parent’s business and therefore, an extension of its own business.
– Write-offs: The subsidiary is considered an extension of the parent company, making the loan write-off arising from investments into the subsidiary a legitimate business loss which should be deductible.
– Transfer Pricing: Interest rates must be at arm’s length in case of loans extended by the parent; however, if the said loans are structured as quasi-equity (e.g., perpetual loans or CCDs), the said benchmarking may not be subject to the same rigors of arms’ length pricing. However, except in the case of perpetual debt, CCDs or CCPS may face restrictions on repatriation unless structured via buybacks or secondary exits.
2) ODI Rules
– Loans to Subsidiaries: Loans to foreign subsidiaries are allowed under ODI regulations only if the Indian parent holds more than 10% voting rights (control).
– Loan Write-Offs: The 2022 ODI Rules permit loan write-offs if the foreign subsidiary incurs losses – this was restricted under the pre-2022 ODI framework.
3) IndAS Perspective – Nature of Instrument Determines Classification: a) Perpetual loans or CCPs/ CCDs with fixed-for-fixed conversion clauses will be treated as equity under IndAS. Instruments with both debt and equity characteristics may be classified as hybrids, depending on the terms of conversion or repayment.
4) Companies Act: Net Worth Calculation and ODI Limits
– Net Worth Definition: Even if classified as equity under IndAS, instruments such as perpetual loans and CCDs will not be considered part of net worth under the Companies Act unless they are shares (i.e., equity or CCPS).
– 400% Net Worth Cap on ODI: Since perpetual loans and CCDs do not contribute to net worth under the Companies Act, they will not count toward the 400% limit on ODI investments.