By Sunil Gidwani
NBFCs play a crucial role in lending to businesses. Over the years, RBI has tightened NBFC regulatory framework especially for large and deposit taking NBFC and brought it close to the regulations applicable to the Banks.
However, the tax laws have not kept pace and hence there are several areas in which NBFCs suffer higher tax cost or compliance burden as compared to banks. We have highlighted below key changes required to bring NBFCs at par with banks.
Exemption for NBFC from thin capitalization rules
Currently, transfer pricing provisions provide that when an Indian company or a permanent establishment of a foreign company pays interest to an associated enterprise, then total interest deduction shall be capped at 30% of EBITDA. However, this capitalization rule does not apply to an Indian bank or a branch of a foreign bank. Considering Banks and NBFC, both being regulated by RBI and perform similar functions as bank, extending the exemption to NBFCs will create a more level playing field for all stakeholders especially NBFCs with significant foreign ownership.
Taxation of interest on NPAs on accrual basis.
As per IT provisions, interest income from NPAs, is to be taxed on credit to profit & loss account or when it is actually received, whichever is earlier. This provision is applicable to all banks, financial institutions, NBFC and HFCs.
However, NBFC and HFCs, adopting IND AS accounting, have to recognise the interest income on the net carrying value of certain category of loans in the profit or loss account, whether or not the company has received or realised such interest income. This anomaly defeats the purpose of introduction of IT provision for taxing such interest income on receipt basis and the NBFC/HFCs end up paying tax on such interest income on accrual basis since credited to profit & loss account. Accordingly, the relevant provisions need an amendment to tax such interest income only on receipt basis.
Exemption from TDS on interest income received by NBFC
Presently, any person (borrower) making interest payments are required to withhold tax at 10% except when such payment is made to banks and public financial institutions. Further foreign banks are issued a Nil withholding order each year to enable them to receive any income without any TDS. However, when borrowers make interest payments made to NBFCs, the payers are required to withhold taxes.
Due to such withholding by borrowers, NBFC face severe cash flow constraints on a thin spread on interest which banks and other public financial institution do not encounter. Sometimes the aggregate TDS for the whole year is in excess of their annual tax liability. Additionally, due to voluminous transactions, NBFCs have to face severe administrative hardships in terms of collection of TDS certificates from their numerous customers. Accordingly, it is advisable to extend the exemption of no TDS to NBFCs and let them pay their tax ad advance tax.
TDS on cash withdrawals by NBFCs
As per the provisions introduced in the Finance Act 2019, any cash withdrawals in excess of INR 1 crore from current account attracts TDS of 2% to be deducted by the payer. Further, an exemption is provided when the payee is government body, banks, white-label ATM operators. In case of NBFCs they withdraw significant cash from banks to make disbursal of small ticket loans and thus, are subject to TDS of 2% by banks on such withdrawals. This impacts the cash flows of the NBFC and hampers its business model severely. The purpose of this TDS was to bring the unaccounted cash transactions within the tax net. One does not need these provisions for an RBI regulated lending institution and hence an exemption for NBFCs should be included.
Exemption benefit on interest on deposits held with HFC/NBFCs
Currently senior citizens are allowed a deduction upto INR 50,000 on interest income earned from saving bank account and fixed deposits held with banks, cooperative societies and post-offices. Fixed deposits accepted by HFC/NBFCs are also subject NHB/RBI regulations and there, interest income earned from deposits with HFC/NBFC should also be granted similar exemption.
NBFCs are now regulated almost like a banking entity. Therefore, for them to compete with banks they deserve a tax regime at par with banks. It is high time government appreciated the long pending requirements of the NBFC industry and resolve the issues faced by them.
(Sunil Gidwani is Partner at Nangia Andersen LLP. With inputs from Naitik Doshi, Associate Director, Nangia Andersen LLP. The views expressed are the authors’ own.)