Government cuts tax to make foreign debt attractive

New Delhi: In a move to lower the cost of borrowings for Indian companies and spur investment, the government on Friday cut the tax it levies on the interest paid on foreign loans to 5% from 20% earlier. Although the move had been announced in the Budget, it came at a time when the government is unleashing a series of measures to get the economy back on track.

So far, if a company was borrowing overseas at 5%, the cost went up to 6% due to the 20% levy. But with the reduced rate of tax, the cost of the same loan would be 5.25%, excluding other costs such as those to hedge interest rate and currency risks.

"This lower rate of taxation will apply to interest paid to a non-resident by an Indian company for money borrowed in foreign currency from a source outside India, either under a loan agreement or by way of long-term infrastructure bonds," the finance ministry said in a statement. As a result, the rate of withholding tax, or the income to withhold or deduct tax from the payment made by a company and transfer the amount to the government, has also been lowered to 5%.

Simultaneously, finance minister P Chidambaram announced that companies that meet specified criteria will now get automatic approval instead of a case-by-case approach. There was almost an immediate cheer from the industry. "The reduction in withholding tax from 20% to 5% will enable corporates to access funds at a cheaper cost. Also, the automatic approval provision makes the process less time-consuming," said Sunil Agarwal, head of Deutsche Bank's institutional client group.

"Reduction in the applicable tax rate and withholding tax will reinforce the overall positivity from the reform measures announced recently. In a global scenario of competing capital destinations, this maintains attractiveness of Indian risk, while giving some advantage to the borrowers. Hopefully, this will provide some more push to investment activity in the country," added Saket Misra, MD (strategic equity solutions) at RBS.

The announcement comes at a time when the government is trying to create conditions - by improving the fiscal situation - to prod RBI into cutting policy rates in its October monetary policy review.