The finance ministry is considering exemption of withholding tax on interest on borrowings from foreign banks to encourage infrastructure financing.

Withholding tax exemptions are granted to attract foreign fund in countries like Singapore and Hong Kong. When an Indian bank raises loans from its overseas branch, it does not have to pay any tax on the money coming into India. But foreign banks have to pay withholding tax on fund raised overseas. The banking division is pushing for the exemption to ensure a level-playing field for foreign and domestic banks.

The withholding tax increases the cost of fund, brought in through these banks, making financing for infrastructure expensive, a source in the government said. The benefit of exemption from withholding taxes will enable the inflow of funds at a low cost that can be channelled into sectors like agriculture, industry and infrastructure, he added.
We are keen on financing infrastructure projects, including ultra mega power projects.

Any move to exempt foreign banks from withholding tax will be a welcome move since it will make the cost of fund cheaper, a top official of a foreign bank said. The investments require huge capital outlay. Banks can raise fund through borrowings from foreign banks in addition to resources raised internally.

Treasury management services in the country will also develop, he added. In its pre-budget memorandum, the Indian Banks Association (IBA) has recommended the exemption under section 10(15)(iv) to be extended to interest on borrowings from foreign lenders. It has said that an earlier provision in the Act provided for exemption from tax on interest on funds borrowed for advancing loans to industrial undertakings for specified purposes. This was deleted in 2001 because it was argued that interest received by the lender is taxable in the country of his residence.

The IBA has said that the foreign lenders invariably enforce the grossing up clause, thus shifting its tax liability in India onto the Indian borrower. The gross up clause mandates all payments to be made in the full amount, free of any deductions or withholdings. Thus, the incidence of withholding tax is on the borrower, when foreign currency borrowings are raised. The lender usually demands gross payments, which are not net of taxes.