MUMBAI: Real estate and infrastructure companies, already struggling with thin profit margins, could see a substantial fall in profits and a significant rise in tax liability next year due to the ‘thin capitalisation’ concept unveiled in the Union Budget for 2017-18. The new rule will not allow companies to claim tax deduction for interest paid on foreign debt above 30% of their EBITDA (earnings before interest, tax, depreciation and amortisation).
Experts say the most hit would be real estate and infrastructure companies that have large chunk of international debt at project level or in their special purpose vehicles (SPVs). The government is expected to categorise investments through non-convertible debentures (NCDs) and the dividend paid on that also as debt.
Several real estate and infrastructure companies or SPVs that have high foreign debt could be hit by the new rule, said Amrish Shah, senior advisor, transaction tax, EY. “However, some of the companies with high profit margins will recover this within a couple of years as they would carry forward the unabsorbed interest,“ he added.
Thin capitalisation concept would apply to all companies operating in India beginning April 2017, in line with the Base Erosion and Profit Shifting (BEPS) framework, a global agreement with 15 action points to check tax avoidance by multinationals. India has already adopted some of these points.
Until now Indian companies used to benefit from dividend distribution (or interest paid) to their investors or debtors located abroad. “Dividend has DDT (dividend distribution tax) and hence, paying interest was the most tax-efficient method to remit money outside India, since even tax withholding was eligible for tax credit unlike DDT. Hence, some companies may look at reworking their capital structure using convertible instruments or simply adjust their coupon rates,“ said Jeenendra Bhandari, partner, MGB and Co LLP.
Typically, EBITDA is profit before any deductions. Most real estate companies deduct interest paid on debt by subsidiaries or SPVs from their consolidated EBITDA. As per the new rule, the interest deduction cannot be more than 30% of EBITDA.
“Certain sectors, especially real estate and infrastructure, are highly leveraged, and significant funding is made by offshore-related parties. Since interest above 30% of EBITDA would not be allowed as deduction, these sectors would be most impacted,“ said Rajesh H Gandhi, partner, Deloitte Haskins & Sells.
Real estate and infrastructure sectors, which were suffering from thin profit margins, used to get most of their debt investments through Cyprus. With the government renegotiating the tax treaty with Cyprus in 2016, all investments coming through the country would attract additional tax from April 2017.
Credits ET Realty