# Thin Capitalisation in India and the 30 Percent EBITDA Interest Cap

> Source: https://krystal7.com/insights/interest-limitation-thin-capitalisation-india
> Publisher: Krystal7 Consultants (Krystal7 Innovations Private Limited), Gurugram, India
> Author: CA Nandini
> Published: 30 Jan 2026; updated 24 Oct 2026
> Summary: India caps interest on debt from a foreign associated enterprise at 30 percent of EBITDA once that interest exceeds INR 1 crore in a tax year.

*Written by CA Nandini Hasija, Krystal7 Consultants. Last updated 23 October 2026.*

## AI Overview Summary

- India's thin capitalisation rule is section 177 of the Income Tax Act, 2025, which replaced section 94B from 1 Apr 2026. It limits interest on debt from a non resident associated enterprise.
- The rule applies once interest on such debt exceeds INR 1 crore in a tax year. The disallowance is the lower of total interest above 30 percent of EBITDA and associated enterprise interest.
- A loan from an unrelated lender counts as associated enterprise debt where a group company guarantees it or deposits matching funds with the lender, under section 177(2).
- Disallowed interest carries forward for eight tax years under section 177(6). It is deductible later only within the 30 percent of EBITDA room of each year.
- Banks, insurers and IFSC finance companies are outside the rule, as is any NBFC class the Central Government notifies. So is interest on a loan from the Indian branch of a foreign bank.

**India's thin capitalisation rule is section 177 of the Income Tax Act, 2025. It replaced section 94B of the Income Tax Act, 1961 from 1 Apr 2026. It applies when an Indian company or Indian PE of a foreign company pays over INR 1 crore of interest to a non resident associated enterprise. Interest above 30 percent of EBITDA is disallowed, capped at the associated enterprise interest. The disallowed amount carries forward for eight tax years.**

This page is for foreign parents that fund an Indian subsidiary with loans, and for the subsidiary's finance team. It covers who the rule hits, the arithmetic, guarantees, exclusions, the ECB link, transfer pricing and a worked example. Amounts are in lakh and crore, so INR 1 crore is INR 100 lakh.

## What is the thin capitalisation rule in India?

India's thin capitalisation rule limits the interest an Indian borrower can deduct on debt from a foreign group company. Section 94B of the Income Tax Act, 1961 brought it in from 1 Apr 2018, for assessment year 2018-19 onwards. Section 177 of the Income Tax Act, 2025 carries the same rule from tax year 2026-27.

The Memorandum to the Finance Bill, 2017 explained the reason. It said "debt is often a more tax efficient method of finance than equity". It said the new rule was "in line with the recommendations of OECD BEPS Action Plan 4". Interest cuts the Indian tax base, while the parent may pay less tax on that interest at home.

India did not adopt a debt to equity ratio test. It chose an earnings test. Section 177 does not ask how much the subsidiary borrows. It asks how much interest the subsidiary deducts against its EBITDA.

The 2025 Act keeps section 177 inside Chapter X, which deals with avoidance of tax. The same chapter holds the transfer pricing provisions, so the meaning of associated enterprise in section 162 applies to it. Our guide to [Income Tax Act, 2025 changes for foreign owned companies](/insights/income-tax-act-2025-changes-for-foreign-owned-companies) covers the wider renumbering.

## Who does section 177 apply to?

Section 177 applies to an Indian company, or a permanent establishment in India of a foreign company, that is the borrower. It applies to interest on debt issued by a non resident associated enterprise, or deemed to be so issued. It bites only where that interest exceeds INR 1 crore in the tax year and is deductible as business income.

| Borrower or lender | Is section 177 relevant? | Provision |
|---|---|---|
| Indian Private Limited company borrowing from its foreign parent | Yes, once interest on the parent debt exceeds INR 1 crore | 177(1) |
| Indian company borrowing from a foreign sister company | Yes, a sister company under common control is an associated enterprise | 177(1), 162 |
| Branch or project office of a foreign company borrowing from a group company abroad | Yes, the branch is a PE of a foreign company | 177(1) |
| Indian company borrowing from an unrelated foreign bank against a parent guarantee | Yes, the debt is deemed associated enterprise debt | 177(2) |
| Indian company borrowing from the Indian branch of a foreign bank | No | 177(3)(a) |
| Indian bank or insurance company as borrower | No | 177(3)(b) |
| Finance company in an IFSC as borrower | No | 177(3)(b) |
| A notified class of NBFC as borrower | No | 177(3)(b) |
| Limited liability partnership borrowing from a foreign partner | No, an LLP is not a company | 177(1) |
| Indian company borrowing only from Indian lenders with no group guarantee | No | 177(1) |

Source: section 177 of the Income Tax Act, 2025.

Section 177(1) opens with the words "irrespective of anything contrary in this Act". So the cap applies even where the interest would otherwise be fully deductible.

Ownership of the borrower does not matter. An Indian owned company that borrows from its own overseas subsidiary is also inside the rule. The trigger is a non resident associated enterprise on the lending side, or behind the lender.

## What counts as debt and as an associated enterprise?

Section 177(7)(a) defines debt widely. It covers any loan, financial instrument, finance lease, financial derivative or arrangement that gives rise to interest, discounts or other finance charges. Those charges must be deductible in computing business income. In our reading, interest on compulsorily convertible debentures held by a parent falls inside this definition. Our batch guide to [CCDs and preference shares under FDI](/insights/compulsorily-convertible-debentures-ccd-preference-shares-fdi) covers the FEMA side of those instruments.

Section 162 of the Income Tax Act, 2025 gives the associated enterprise tests. They replace old section 92A.

| Test in section 162(1) | Threshold | Typical Indian subsidiary case |
|---|---|---|
| Participation in management, control or capital | Direct or indirect participation | Foreign parent owns the subsidiary |
| Voting power | 26 percent or more in the tax year | Parent holds 26 percent or more of the shares |
| Loan | Loan of at least 51 percent of the book value of the borrower's total assets | A large parent loan creates the link even without shares |
| Guarantee | Guarantee of at least 10 percent of the borrower's total borrowings | Group guarantee to the borrower's lenders |
| Board control | Appoints more than half of the board, or one or more executive directors | Parent nominee directors |
| Know how dependence | Business wholly dependent on the other's know how or patents | Licensed technology subsidiary |
| Supply or sales | Supplies 90 percent or more of raw materials, or buys the output, at prices and terms it influences | Captive contract manufacturer |

Source: section 162 of the Income Tax Act, 2025.

Most foreign owned subsidiaries meet the first or second test through shareholding alone. The other tests matter where a foreign lender holds no shares. A lender that provides at least 51 percent of the borrower's assets becomes an associated enterprise through the loan.

## How is the 30 percent of EBITDA cap calculated?

Section 177(4) defines excess interest as the lower of two amounts. The first is total interest paid or payable in the tax year above 30 percent of the borrower's EBITDA. The second is interest paid or payable to associated enterprises in that year. The excess interest is not deductible that year.

The computation runs in four steps:

1. Check the trigger. Is interest on debt from non resident associated enterprises, including deemed debt, above INR 1 crore? If not, stop.
2. Compute 30 percent of EBITDA for the tax year.
3. Subtract that figure from total interest, which includes interest to unrelated lenders.
4. Compare the result with associated enterprise interest. The lower figure is the excess interest.

Two points follow from the formula. Interest to Indian banks uses up the 30 percent room, even though that interest is never disallowed itself. And the disallowance can never exceed the associated enterprise interest.

A loss making borrower is hit hardest. If EBITDA is zero or negative, the 30 percent room is nil. Excess interest is then total interest, capped at associated enterprise interest. So a start up subsidiary funded by a parent loan can lose its whole deduction for parent interest in early years. The carry forward under section 177(5) and (6) gives that deduction back only when EBITDA grows.

### What EBITDA means here

Section 177 uses the words "earnings before interest, taxes, depreciation and amortisation of the borrower". It does not define them. It does not say whether you start from the profit and loss account or from computed taxable income. The 1961 text had the same gap.

We compute EBITDA from the audited profit and loss account prepared under Schedule III to the Companies Act, 2013. We add back finance cost, tax expense, depreciation and amortisation. We keep the working with the tax audit file, because an Assessing Officer may argue for a tax based figure. Where the two readings give very different results, we flag the point to the board before the return is filed.

## Does a parent guarantee bring third party loans into the rule?

Yes. Section 177(2) treats a debt from an unrelated lender as issued by an associated enterprise in two cases. One is where an associated enterprise gives the lender an implicit or explicit guarantee. The other is where it deposits corresponding and matching funds with the lender. Interest on that loan then counts towards the INR 1 crore trigger and the associated enterprise interest.

| Funding route | Treated as associated enterprise debt? | Why |
|---|---|---|
| Loan from a foreign bank backed by a parent corporate guarantee | Yes | Explicit guarantee, 177(2) |
| Loan from a foreign bank backed by a comfort letter that the bank relies on | Likely yes | Implicit guarantee, 177(2) |
| Back to back loan where the parent places a matching deposit with the bank | Yes | Matching funds, 177(2) |
| Loan from an Indian bank against a standby letter of credit issued for the parent | At risk; see our reading below | Guarantee by a non resident associated enterprise |
| Loan from the Indian branch of a foreign bank | No | Excluded by 177(3)(a) |
| Unsecured loan from an unrelated foreign lender with no group support | No | Not an associated enterprise |

Source: section 177(1) to (3) of the Income Tax Act, 2025.

Section 177(2) does not say the lender must be non resident. Our reading is that an Indian bank loan backed by a foreign parent's guarantee is at risk of falling inside the rule. Some practitioners read the deeming rule as limited to non resident lenders. We plan for the wider reading and document the commercial reason for each guarantee.

## Which businesses and loans are excluded?

Section 177(3) excludes two groups. Clause (a) excludes interest on debt issued by a lender that is a PE in India of a non resident bank. Clause (b) excludes borrowers in banking or insurance and a finance company in an International Financial Services Centre (IFSC). It also excludes any class of non banking financial companies the Central Government notifies.

Each exclusion entered the 1961 Act at a different time:

1. **Banks and insurers as borrowers.** Section 94B(3) excluded them from the start, 1 Apr 2018.
2. **Loans from the Indian branch of a foreign bank.** The Finance Act, 2020 added section 94B(1A) from 1 Apr 2021. The Memorandum explained that a foreign bank's Indian branch is a non resident, so its loans could otherwise fall within the rule.
3. **Notified classes of NBFC.** The Finance Act, 2023 (Act No. 8 of 2023) let the Central Government notify classes of NBFC, from 1 Apr 2024. The section 94B text on incometaxindia.gov.in cites no notification. We have not found one under section 94B(3) or section 177(3)(b). CBDT Notification No. 80/2023 ([S.O. 4193(E)](https://egazette.gov.in/WriteReadData/2023/248898.pdf), 22 Sep 2023) notified top, upper and middle layer NBFCs for section 43B(da) only. An NBFC borrower should check the CBDT notifications page before it relies on this exclusion.
4. **Finance companies in an IFSC.** The Finance (No. 2) Act, 2024 (Act No. 15 of 2024) added them from 1 Apr 2025. The Memorandum said the rule "shall not apply to finance companies, located in IFSC".

Section 177(7)(b) defines a finance company by reference to regulation 2(1)(e) of the IFSCA (Finance Company) Regulations, 2021. It must also meet prescribed conditions and carry on prescribed activities.

A group treasury company in an IFSC that lends to an Indian subsidiary is a different case. The IFSC exclusion protects the IFSC finance company as a borrower. It does not protect an Indian subsidiary that borrows from it. That subsidiary still tests its interest under section 177.

## How does section 177 interact with an ECB from the parent?

An ECB from a foreign parent is the most common source of associated enterprise debt. FEMA governs whether you may borrow. Section 177 governs how much of the interest you may deduct. The two tests are separate, so a loan can comply fully with FEMA and still lose part of its interest deduction.

| Question | FEMA answer | Income tax answer |
|---|---|---|
| Can the parent lend? | Yes, a non resident person is a recognised lender, regulation Schedule I para 2 | Interest is associated enterprise interest under 177 |
| What interest rate? | Related party ECB must be on an "arm's length basis" (Schedule I para 9); cost "in line with prevailing market conditions" (para 7(1)) | Arm's length price under the transfer pricing provisions, sections 161 to 173 |
| How much can be borrowed? | Higher of USD 1 billion or total borrowing up to 300 percent of net worth (para 5(1)) | No borrowing limit; interest deduction capped at 30 percent of EBITDA |
| Minimum maturity | Average of three years; one to three years for manufacturers up to USD 150 million (para 6) | No maturity test |
| Before drawdown | LRN through the AD bank (para 10(1)) | Form 145 and, where needed, Form 146 before each interest remittance |
| Ongoing reporting | Form ECB 2 within seven calendar days after each month (para 16(1)(c)) | TDS statement Form 144 each quarter |
| Conversion to equity | Allowed under the Non Debt Instruments Rules, 2019 with lender consent (para 13) | Conversion ends future interest and the section 177 exposure |

Sources: FEMA 3(R)(5)/2026-RB of 9 Feb 2026; sections 162, 177 and 393 of the Income Tax Act, 2025.

The 2026 amendment regulations apply to ECBs whose LRN is obtained after they take effect. ECBs with an earlier LRN continue under the earlier terms, but reporting follows the amended rules. Our guide to an [ECB from a foreign parent](/insights/ecb-loan-from-foreign-parent-india) covers the FEMA side in full. Where the cap bites every year, a parent often converts part of the loan to equity. Our guide on [converting a loan into equity](/insights/conversion-of-loan-into-equity-india-foreign-parent) explains the steps.

### Tax on the interest itself

The Indian subsidiary deducts tax on interest paid to its parent under section 393(2), Table serial 17. Interest on foreign currency borrowings bears 20 percent for a foreign company, plus surcharge and cess. Part II of the First Schedule to the Finance Act, 2026 sets that rate. A treaty rate applies where the parent holds a TRC and files Form 41. The 5 percent rate in Table serial 2 covers only borrowings made from 1 Jul 2012 to 30 Jun 2023.

Section 177 does not reduce the withholding. The subsidiary deducts tax on the full interest paid, including the part it cannot deduct. So excess interest costs twice: Indian tax on the parent's interest income, and no deduction for the subsidiary. Our guide to [TDS on payments to non residents](/insights/tds-on-payments-to-non-residents) covers the treaty rates.

## How does transfer pricing apply before the 30 percent cap?

Interest on a parent loan is an international transaction. It must be at arm's length under sections 161 to 173 of the Income Tax Act, 2025. Section 177 then caps the arm's length interest that remains. The transfer pricing adjustment and the section 177 disallowance are two separate amounts, and both can arise in the same year.

We run the steps in this order:

1. Benchmark the interest rate and any guarantee fee. Reduce the deduction to the arm's length amount.
2. Check TDS on the interest. Interest paid without TDS is disallowed under section 35(b)(ii) until the tax is paid.
3. Apply section 177 to the deductible interest that remains.

The order is our practice. Section 177 does not prescribe it. Applying the cap to interest already disallowed would count the same rupee twice, which no provision supports.

The transfer pricing report goes in Form 48 (old Form 3CEB) under section 172. The interest and the section 177 working should tie to that report. Our guides to [arm's length price methods](/insights/arms-length-price-methods-in-india) and [transfer pricing between a US parent and an Indian subsidiary](/insights/transfer-pricing-us-parent-indian-subsidiary) cover benchmarking. Our [transfer pricing advisory](/services/transfer-pricing-advisory.html) team prepares the interest benchmark and Form 48.

## How long can disallowed interest be carried forward?

Excess interest carries forward to the following tax years under section 177(5). It is deductible against business income of a later year, but only up to that year's room under the 30 percent cap. Section 177(6) stops the carry forward after eight tax years from the year the excess interest was first computed.

Old section 94B(4) had the same eight year limit, counted in assessment years. The Income Tax Act, 2025 counts in tax years.

Section 536 of the Income Tax Act, 2025 holds the transition rules. Its clauses on losses, allowances and MAT credit do not name section 94B. The CBDT clarificatory FAQs on transition provisions (July 2026) also do not address it. We read section 536(2)(b), which preserves rights acquired under the 1961 Act, as carrying old excess interest into section 177. The original eight year window keeps running.

| Year excess interest first computed | Last year it can be set off |
|---|---|
| Assessment year 2019-20 (financial year 2018-19) | Assessment year 2027-28, which is tax year 2026-27 |
| Assessment year 2022-23 (financial year 2021-22) | Tax year 2029-30 |
| Assessment year 2026-27 (financial year 2025-26) | Tax year 2033-34 |
| Tax year 2026-27 | Tax year 2034-35 |

Source: section 94B(4) of the Income Tax Act, 1961 and section 177(6) of the Income Tax Act, 2025. The mapping of old years to tax years is our reading.

## What changed in 2026

The core rule did not change in 2026. Section 177 reproduces section 94B with the same INR 1 crore trigger, 30 percent cap and eight year carry forward. Three other changes in 2026 affect a subsidiary funded by its parent.

| Old rule | New rule | Date | Instrument |
|---|---|---|---|
| Section 94B of the Income Tax Act, 1961 | Section 177 of the Income Tax Act, 2025, same tests | 1 Apr 2026 (tax year 2026-27) | Income Tax Act, 2025 |
| Associated enterprise defined in section 92A | Defined in section 162 | 1 Apr 2026 | Income Tax Act, 2025 |
| Carry forward for eight assessment years | Carry forward for eight tax years | 1 Apr 2026 | Section 177(6) |
| ECB terms under the 2018 regulations and the earlier ECB directions | Related party ECB on an arm's length basis; cost in line with market conditions; borrowing limit of USD 1 billion or 300 percent of net worth | Regulations dated 9 Feb 2026, effective on Gazette publication | FEMA 3(R)(5)/2026-RB |
| MAT at 15 percent with credit | MAT at 14 percent under section 206 with no new credit, for companies outside section 200 | 1 Apr 2026 | Finance Act, 2026 |
| Interest to non residents under section 195 | Section 393(2), Table serial 17 | 1 Apr 2026 | Income Tax Act, 2025 |

Sources: sections 94B, 162, 177 and 393; FEMA 3(R)(5)/2026-RB; Income Tax Department MAT and AMT page.

The MAT change matters because section 177 adds back interest only in the tax computation. Book profit does not change. A company that stays outside section 200 pays the higher of normal tax and MAT at 14 percent, and no new MAT credit accrues. A large section 177 add back can push its normal tax above MAT.

### What has happened since 30 Jan 2026

1. **1 Feb 2026.** The Union Budget proposed MAT at 14 percent from tax year 2026-27 with no new MAT credit.
2. **9 Feb 2026.** RBI issued FEMA 3(R)(5)/2026-RB, the new ECB framework in Schedule I to the Borrowing and Lending Regulations. It applies from its Gazette publication to ECBs with a later LRN.
3. **1 Apr 2026.** The Income Tax Act, 2025 came into force. Section 177 replaced section 94B, and section 162 replaced section 92A.
4. **July 2026.** CBDT issued clarificatory FAQs on transition provisions. They say nothing on section 94B carry forward. Our batch guide to [minimum alternate tax for foreign companies](/insights/minimum-alternate-tax-foreign-companies-india) covers the regime choice.

## Worked example

An Indian Private Limited subsidiary of a German parent borrows two ways. It has an ECB from the parent at 9 percent and a term loan from an Indian bank with no group guarantee. Assume the parent interest is at arm's length and TDS was paid on time.

### Year 1, tax year 2026-27

| Item | Amount (INR lakh) |
|---|---|
| EBITDA from the audited profit and loss account | 2,000 |
| Interest on the ECB from the German parent | 800 |
| Interest on the Indian bank loan | 200 |
| Total interest | 1,000 |
| 30 percent of EBITDA | 600 |
| Total interest above 30 percent of EBITDA (1,000 minus 600) | 400 |
| Interest to associated enterprises | 800 |
| Excess interest, the lower of 400 and 800 | 400 |
| Interest allowed this year (1,000 minus 400) | 600 |
| Excess interest carried forward | 400 |

The trigger is met, because parent interest of INR 800 lakh exceeds INR 1 crore. The company loses a deduction of INR 4 crore this year. If it pays tax under section 200 at 22 percent, before surcharge and cess, that is INR 88 lakh of extra tax.

The INR 2 crore of bank interest is never disallowed itself. It uses up a third of the INR 6 crore room. Without the bank loan, the excess would have been INR 2 crore, not INR 4 crore.

### Year 2, tax year 2027-28

EBITDA rises to INR 3,000 lakh. The company repays part of the ECB, so parent interest falls to INR 500 lakh. Bank interest stays at INR 200 lakh.

| Item | Amount (INR lakh) |
|---|---|
| Total interest this year (500 plus 200) | 700 |
| 30 percent of EBITDA | 900 |
| Room left under the cap (900 minus 700) | 200 |
| Excess interest brought forward from year 1 | 400 |
| Brought forward interest set off this year | 200 |
| Brought forward interest carried to year 3 | 200 |

The current year interest is fully deductible, because INR 700 lakh is below the INR 900 lakh cap. The company also sets off INR 200 lakh of the year 1 excess. The remaining INR 200 lakh carries forward and lapses after tax year 2034-35 if unused.

### A loss making start up

A second subsidiary has negative EBITDA of INR 150 lakh and pays INR 120 lakh interest on a parent loan. It has no other debt. The trigger is met, because INR 120 lakh exceeds INR 1 crore. The 30 percent room is nil, so the whole INR 120 lakh is excess interest. It carries forward for eight tax years and becomes deductible only when EBITDA turns positive.

Suppose the parent loan carries 9 percent interest. Had the parent lent INR 3 crore less, interest would have fallen by INR 27 lakh to INR 93 lakh, below the trigger. Then no disallowance would arise at all. We test the trigger before the parent sizes each tranche.

## Common mistakes

1. **Treating INR 1 crore as an allowance.** Once associated enterprise interest exceeds INR 1 crore, the whole computation applies. Fix: compute the full 30 percent test once you cross the trigger.
2. **Leaving bank interest out of total interest.** Interest to unrelated lenders counts in total interest. Fix: include every interest and finance charge in step 3.
3. **Ignoring parent guarantees.** A guaranteed loan from a foreign bank is deemed associated enterprise debt under section 177(2). Fix: list every guarantee, comfort letter and standby letter of credit each year.
4. **Using a pre tax profit figure as EBITDA.** EBITDA adds back interest, depreciation and amortisation. Fix: start from the Schedule III profit and loss account and show each add back.
5. **Forgetting compulsorily convertible debentures.** Interest on them is debt interest under section 177(7)(a). Fix: include CCD coupons from the parent in the computation.
6. **Losing track of carried forward interest.** It lapses after eight tax years. Fix: keep a year by year schedule with the first year and the last year of set off.
7. **Assuming an IFSC lender protects the borrower.** The IFSC exclusion covers the IFSC finance company as borrower only. Fix: test an Indian subsidiary's interest to a group IFSC entity under section 177.
8. **Booking interest above arm's length and then applying the cap.** Transfer pricing adjusts the rate first. Fix: benchmark the rate, then apply section 177 to what remains.

If you want us to model section 177 before a parent loan is drawn, send us the draft loan terms and the last audited accounts.

## Checklist

1. List every loan, debenture, finance lease and guarantee that involves a non resident group company.
2. Confirm each lender or guarantor is an associated enterprise under section 162.
3. Benchmark the interest rate and any guarantee fee at arm's length.
4. Total interest on associated enterprise debt, including deemed debt, and compare it with INR 1 crore.
5. Compute EBITDA from the audited profit and loss account and keep the working.
6. Calculate excess interest as the lower of total interest above 30 percent of EBITDA and associated enterprise interest.
7. Add back the excess interest in the return for the tax year.
8. Record the excess interest in a carry forward schedule with its eight year end date.
9. Set off brought forward excess interest within each later year's spare room under the cap.
10. Reassess the debt and equity mix before new parent loans, ECB tranches or conversions.

## Key terms

- **Thin capitalisation**: Funding a company with far more debt than equity, often from its own group, so that interest deductions reduce taxable profit. India counters it with section 177 of the Income Tax Act, 2025 (old section 94B), which caps related party interest by reference to EBITDA. (https://krystal7.com/glossary#thin-capitalisation)
- **Excess interest**: Under section 177(4) of the Income Tax Act, 2025, the lower of two figures for a tax year. One is total interest above 30 percent of EBITDA. The other is interest paid or payable to associated enterprises. Excess interest is not deductible that year. (https://krystal7.com/glossary#excess-interest)
- **Associated Enterprise (AE)**: A company that participates directly or indirectly in the management, control or capital of another, or is under common control with it, as the transfer pricing provisions of the Income Tax Act, 2025 define it (old section 92A). An Indian company and its foreign parent are usually associated enterprises, so their dealings must be at arm's length. (https://krystal7.com/glossary#associated-enterprise)
- **EBITDA**: Earnings before interest, taxes, depreciation and amortisation. Section 177 of the Income Tax Act, 2025 uses 30 percent of the borrower's EBITDA as the interest cap but does not define the term or say how to compute it. (https://krystal7.com/glossary#ebitda)
- **External Commercial Borrowing (ECB)**: An ECB is a borrowing by an eligible Indian borrower from a recognised lender resident outside India, governed by the Foreign Exchange Management (Borrowing and Lending) Regulations as amended in 2026. A foreign parent can be a recognised lender. The loan needs a Loan Registration Number before drawdown and monthly reporting in Form ECB 2. (https://krystal7.com/glossary#external-commercial-borrowing)
- **Loan Registration Number (LRN)**: An LRN is the number allotted to an external commercial borrowing through the borrower's AD bank before drawdown, under the FEMA borrowing and lending regulations. It identifies the loan in all later reporting. A parent loan drawn without one is a FEMA gap to fix through the AD bank or RBI compounding. (https://krystal7.com/glossary#loan-registration-number)

## Frequently Asked Questions

### What is thin capitalisation in Indian tax law?

Thin capitalisation means funding an Indian company with heavy group debt so that interest cuts its taxable profit. India counters it with section 177 of the Income Tax Act, 2025, which replaced section 94B from 1 Apr 2026. It caps deductible interest on debt from non resident associated enterprises at 30 percent of EBITDA.

### Which section replaced section 94B?

Section 177 of the Income Tax Act, 2025 replaced section 94B of the Income Tax Act, 1961 from tax year 2026-27. Section 177 keeps the INR 1 crore trigger, the 30 percent of EBITDA cap, the guarantee rule and the eight year carry forward. It counts the carry forward in tax years instead of assessment years.

### Does the 30 percent cap apply to all interest or only parent interest?

The disallowance can only come from associated enterprise interest, but the cap is measured on total interest. Section 177(4) takes total interest above 30 percent of EBITDA, then caps the disallowance at interest paid to associated enterprises. So interest to Indian banks reduces the room even though it is never disallowed itself.

### Is the first INR 1 crore of parent interest always deductible?

No. INR 1 crore is a trigger, not an exemption. If interest on associated enterprise debt is INR 1 crore or less, section 177 does not apply at all. Once it exceeds INR 1 crore, the full 30 percent of EBITDA test applies to all interest. The disallowance can then exceed the amount above INR 1 crore.

### Does a parent guarantee on a bank loan count?

Yes, where the guarantee is given to the lender. Section 177(2) of the Income Tax Act, 2025 deems an unrelated lender's loan to be associated enterprise debt in two cases. The first is an implicit or explicit guarantee by an associated enterprise. The second is a matching deposit with the lender. Interest on that loan then counts as associated enterprise interest.

### Are banks and NBFCs covered by the interest limitation rule?

Indian companies and PEs in banking or insurance are excluded by section 177(3)(b) of the Income Tax Act, 2025. So are finance companies in an IFSC and any class of NBFCs the Central Government notifies. We have found no NBFC notification under section 94B(3) or 177(3)(b), so check before relying on it. Interest on a loan from the Indian branch of a foreign bank is also excluded, under section 177(3)(a).

### How is EBITDA calculated for section 177?

Section 177 of the Income Tax Act, 2025 does not define EBITDA or say how to compute it. We start from the audited profit and loss account under Schedule III to the Companies Act, 2013. We add back finance cost, tax, depreciation and amortisation. The working should sit with the tax audit file in case the officer argues for a tax based figure.

### What happens if EBITDA is negative?

The 30 percent room is then nil, so all interest is above the cap. The disallowance equals total interest, capped at associated enterprise interest, once the INR 1 crore trigger is met. The disallowed amount carries forward under section 177(5) for eight tax years and becomes deductible when EBITDA turns positive.

### How long can disallowed interest be carried forward?

Section 177(6) of the Income Tax Act, 2025 allows carry forward for up to eight tax years. The count starts after the year the excess interest was first computed. Old section 94B(4) gave the same eight years, counted in assessment years. In each later year, the brought forward amount is deductible only within that year's spare room under the cap.

### Does section 177 apply to an LLP or a branch office?

It does not apply to a limited liability partnership. Section 177(1) covers only an Indian company and a PE in India of a foreign company. A branch or project office of a foreign company is a PE, so it is covered when it borrows from a non resident group company.

### Does an ECB that complies with FEMA escape section 177?

No. FEMA decides whether the loan is allowed and on what terms. Section 177 of the Income Tax Act, 2025 separately caps the interest deduction. A related party ECB must be on an arm's length basis under FEMA 3(R)(5)/2026-RB. Its interest still counts as associated enterprise interest for the 30 percent of EBITDA test.

### Is TDS still due on interest that section 177 disallows?

Yes. The Indian borrower deducts tax on the full interest paid to the non resident lender. Section 393(2), Table serial 17 of the Income Tax Act, 2025 applies. Section 177 limits only the borrower's deduction. It does not change the lender's income or the withholding rate, which is 20 percent for foreign currency loans before any treaty relief.

### Is interest on compulsorily convertible debentures covered?

Yes. Section 177(7)(a) of the Income Tax Act, 2025 defines debt to include any financial instrument that gives rise to deductible interest. Interest on compulsorily convertible debentures held by a foreign parent is therefore associated enterprise interest, even though FEMA treats the debentures as equity instruments.

### Does section 177 change book profit for MAT?

No. Section 177 works only in computing business income under the Income Tax Act, 2025. Book profit under section 206 starts from the profit and loss account, where the interest stays deducted. A company outside section 200 compares normal tax, after the add back, with MAT at 14 percent from tax year 2026-27.

### Does section 177 apply to interest on trade payables to the parent?

Section 177(7)(a) covers any arrangement that gives rise to interest or finance charges deductible as business expense. Interest charged by a foreign parent on overdue trade payables can fall inside that definition. Plain trade credit with no interest does not create section 177 exposure, though FEMA rules on import payments still apply.

## Sources

- Income Tax Department, Income Tax Act, 2025, section 177 (limitation on interest deduction in certain cases), https://www.incometaxindia.gov.in/w/section-177-77
- Income Tax Department, Income Tax Act, 1961, section 94B as amended to the Finance (No. 2) Act, 2024, https://www.incometaxindia.gov.in/w/section-94b-8
- Income Tax Department, Income Tax Act, 1961, section 94B as inserted by the Finance Act, 2017, https://www.incometaxindia.gov.in/w/section-94b
- Income Tax Department, Income Tax Act, 2025, section 162 (meaning of associated enterprise), https://www.incometaxindia.gov.in/w/section-162-86
- Income Tax Department, Income Tax Act, 2025, section 536 (repeal and savings), https://www.incometaxindia.gov.in/w/section-536-1
- CBDT, Clarificatory FAQs on transition provisions under section 536, July 2026, https://www.incometaxindia.gov.in/documents/81799/15800173/FAQs-on-Transition-Provisions.pdf/f12b6c7c-1023-be74-8a3f-964563286129?t=1783342520234
- Income Tax Department, Income Tax Act, 2025, section 393, https://www.incometaxindia.gov.in/w/section-393-6
- Income Tax Department, Finance Act, 2026, First Schedule, https://www.incometaxindia.gov.in/w/first-schedule-104
- Income Tax Department, MAT and AMT, https://www.incometaxindia.gov.in/w/mat-and-amt
- Ministry of Finance, Memorandum explaining the provisions in the Finance Bill, 2017, https://www.indiabudget.gov.in/budget2017-2018/ub2017-18/memo/memo.pdf
- Ministry of Finance, Memorandum explaining the provisions in the Finance Bill, 2020, https://www.indiabudget.gov.in/budget2020-21/doc/memo.pdf
- Ministry of Finance, Memorandum explaining the provisions in the Finance (No. 2) Bill, 2024, https://www.indiabudget.gov.in/budget2024-25/doc/memo.pdf
- Reserve Bank of India, Foreign Exchange Management (Borrowing and Lending) (First Amendment) Regulations, 2026, FEMA 3(R)(5)/2026-RB, 9 Feb 2026, https://www.rbi.org.in/SCRIPTs/BS_FemaNotifications.aspx?Id=13306
- Central Board of Direct Taxes, Notification No. 80/2023, S.O. 4193(E), 22 Sep 2023 (NBFC classes for section 43B(da)), https://egazette.gov.in/WriteReadData/2023/248898.pdf

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