Taxability Of Loans Between Related Persons Or Group Companies – Impact Assessment W.r.t. 53rd GST Council Meeting

The 53rd GST Council Meeting reiterated that the interest component on loans granted between related persons or group companies remains exempt from GST under Notification No. 12/2017 – Central Tax (Rate). This clarification is crucial for companies engaging in inter-company loans.

Key Points from the Meeting:

• The value of supply between related persons should be based on the open market value or the value of supply of goods or services of like kind and quality.

• For loans between related persons or group companies, the interest charged should reflect the arm's length price.

• Interest on loans provided by one related entity to another is exempt from GST.

• Additional charges such as processing fees or administrative charges are subject to GST.

Background

Under the Goods and Services Tax (GST) regime in India, transactions between related persons or between group companies can be deemed as supplies even if there is no consideration exchanged. This is established under Schedule I of the Central Goods and Services Tax (CGST) Act, 2017. In related-party loans, there is often no processing fee or service charge beyond interest due to existing familiarity and information sharing within the group. This differs from independent lenders, who typically charge processing fees to cover administrative costs and credit assessments. The exemption for the interest component was introduced to address confusion and demands for clarification during GST audits, which led to tax notices.

In order to ensure uniformity, it has been clarified vide the Circular No.218/12/2024-GST dated 26.06.2024 that supply of services of granting loans / credit / advances, in so far as the consideration is represented by way of interest or discount, is fully exempt under GST. Therefore, it cannot be said that any supply is being provided between the related parties in the form of processing / facilitating / administration of loan, by deeming the same as supply of service as per Section 7(1)(c) read along with entry 2 of Schedule I of the CGST Act, 2017. Consequently, no leavy of GST on the same will be liable.

Accordingly, in regards to the proportionate reversal of input tax credit pursuant to this exempt service is not applicable in terms of Explanation (b) to the Rule 43(5) of CGST Rules, 2017. Therefore, it will have no effect on the common credit as well.

Clarification on Taxability

1. Specific Inclusions:
   

   • The term “loans” encompasses a broad range of financial transactions, including advances, deposits, and other forms of financial assistance extended within a corporate group.

   • Such transactions between related persons or group companies are deemed taxable supplies under GST.

2. Valuation for GST Purposes:

   • The value of the loan or financial assistance should be determined as per the GST valuation rules. If interest or other consideration is charged for the loan, that amount is taken as the value of the supply.

   • If no interest is charged, the value of the supply is determined according to Rule 28 of the CGST Rules, which provides for the valuation of supplies between related persons.

3. Impact on Tax Liability:

   • As these transactions are considered as supplies, they attract GST at the applicable rate for such financial services.

   • Businesses must ensure they account for GST on such intra-group financial transactions and remit the appropriate tax to the government.

Income Tax Implications

Interest Deductibility:

• Interest on loans taken from related parties is generally deductible for the borrowing entity, provided the loan is used for business purposes.

• The interest expense must be reasonable and at arm's length to be deductible. Excessive interest rates might be disallowed under Section 40A(2) of the Income Tax Act, 1961.

Deemed Dividend:

• Such loans may be treated as deemed dividends if the company has accumulated profits taxable in the hands of the recipient shareholder.

Thin Capitalization Rules:

• These rules restrict the deductibility of interest paid by an Indian company to its foreign associated enterprises if the debt-equity ratio exceeds a specified threshold (generally 3:1 for other than banking or insurance companies).

• The disallowed interest under thin capitalization rules is not deductible for tax purposes.

Transfer Pricing

Advanced Pricing Agreements (APAs):

• Companies can enter into APAs with tax authorities to agree on transfer pricing methods for loans and interest rates in advance, reducing the risk of future disputes.

Cross-border Loans

Withholding Tax:

• Interest paid on cross-border loans to related entities is subject to withholding tax under the Income Tax Act.

• The rate of withholding tax may be reduced under applicable Double Taxation Avoidance Agreements (DTAAs).

Foreign Exchange Management Act (FEMA) Compliance:

• Loans between Indian entities and their foreign affiliates must comply with FEMA regulations, including the External Commercial Borrowings (ECB) framework.

Transfer Pricing and BEPS:

• Cross-border loans are scrutinized under Base Erosion and Profit Shifting (BEPS) Action Plan 4, which limits the deductibility of interest to combat profit shifting through excessive interest deductions.