Concessional withholding of 5% under Section 194LC / LD for FPIs post
1 July 2023
The taxability of interest income earned by non-residents (including interest on securities) is governed by Section 115A of the Income-tax Act, 1961 (the Act). Furthermore, Section 115AD of the Act specifically deals with the taxability of income earned on securities by Foreign Portfolio Investors (FPIs) or Foreign Institutional Investor (FIIs) or Qualified Foreign Investor (QFIs).
In order to incentivize foreign borrowing, create jobs and stimulate the economy, a concessional rate of tax was introduced in Section 115A and Section 115AD. Corresponding changes for withholding taxes were brought in under Section 194LC and Section 194LD of the Act.
Section 194LC of the Act provides for a concessional rate of Tax Deductible at Source (TDS) at the rate of 5% on certain interest income payable to nonresidents, including inter-alia interest on rupee-denominated bonds. Furthermore, the section specifically provides that the concessional rate of TDS shall apply only on interest arising out of moneys borrowed before 1 July 2023.
Similarly, Section 194LD of the Act provides for a concessional rate of TDS at 5% when FIIs/FPIs earn interest income on rupee-denominated bonds of the Indian company and government securities. Furthermore, this section also specifically states that the concessional rate of 5% would be applicable only for the interest payable to the FIIs/FPIs before 1 July 2023.
For ease of understanding, both Sections are summarized hereunder:
| Particulars | Section 194LC | Section 194LD |
|---|---|---|
| Payer | Indian Company, Business Trust | Any person |
| Payee | Non-resident not being a company or Foreign Company | FIIs/FPIs or QFIs |
| Nature of income |
|
|
| Concessional Withholding Tax Rate | 5% | 5% |
| Cut off for concessional rate of tax | The beneficial rate of 5% withholding is available on interest income arising out of ‘moneys borrowed’ before 1 July 2023. | The beneficial rate of 5% withholding is available on ‘interest payable’ to FIIs/ FPIs on or before 1 July 2023. |
Impact on withholding taxes on interest post 1 July 2023
The Finance Bill 2023 has not provided any extension for the applicability of the concessional rate of withholding under Section 194LC and Section 194LD of the Act. Thus, it appears that going forward, in case of FIIs/FPIs, interest payable to them after 1 July 2023 shall not be eligible for the concessional rate of withholding taxes at 5% even if the moneys were borrowed by an Indian company from such FII/FPI before 1 July 2023.
On the other hand, in case of other non-residents (not being FIIs/FPIs), the interest payable after 1 July 2023 with respect to moneys borrowed before 1 July 2023 shall be continued to be taxable at the concessional rate 5%.
Based on a plain reading of the law, interest on securities earned by FIIs/ FPIs is specifically governed by Section 115AD of the Act. As per the said section, the tax rate applicable on interest income earned on rupeedenominated bonds and government securities post 1 July 2023 would be 20%. The corresponding withholding taxes would be deductible under Section 196D of the Act.
Considering the intention of the legislature while introducing the concessional rates of 5% withholding was to incentivize foreign borrowing to boost the economy, the Sections have been drafted in a manner that contradicts this intention by way of biased taxability for non-residents but carving out FPIs/FIIs.
One may argue that as the benefit of 5% withholding under Section 194LD is not applicable, the FIIs/FPIs may look for shelter under Section 194LC for the 5% withholding in respect of ‘moneys borrowed’ before 1 July 2023 as they are non-residents should also fall within the purview of Section 194LC. This argument may not be sustainable as the Act provides for a separate specific section for taxability of interest on securities earned by FIIs/FPIs (i.e., Section 115AD). It is an established principle that while analyzing the tax laws, the specific sections will prevail over the general taxability.
It is noteworthy that while Section 115AD specifically excludes interest income under Section 194LD for the rate of 20%, once the income stops being a part of Section 194LD (i.e., if payable post 1 July 2023), it would be covered under Section 115AD for which a separate rate of withholding tax at 20% is provided under Section 196D.
For argument’s sake, even if one assumes that since the intention of the statute was the same for providing a beneficial rate of tax to FPIs/FIIs and other non-residents, the benefit under Section 194LC should be extended FPIs/FIIs as well, the taxability in India of such income would still continue to be at 20% under Section 115AD. Thus, even where the withholding taxes are restricted to 5% by relying on Section 194LC for ‘moneys borrowed’ before 1 July 2023, the taxability for FIIs / FPIs would still be at 20% in light of Section 115AD of the Act.
Going forward, it would be interesting to see whether there would be any recommendations being made by FPIs / FIIs on this disparity in the manner in which the cut-off for concessional interest taxation has been drafted and whether the tax department comes with any clarification regarding the same.
Note: The above analysis is strictly restricted to the provisions of the Act, and the taxability under Double Tax Avoidance Agreements has not been discussed. The FII/FPI can still be able to take benefit of the Double Tax Avoidance Agreement (DTAA) if the tax rates are more beneficial than the provision of the Act for such interest.