Section 177 of the Income-tax Act, 2025 — Limitation on Interest Deduction (Thin Capitalisation Rules)

In plain language

What Section 177 is about

Section 177 of the Income-tax Act, 2025 caps how much interest a business can claim as a tax deduction when that interest is paid on money borrowed from a non-resident associated enterprise (AE). It is India's "thin capitalisation" rule and is the direct successor to Section 94B of the old Income-tax Act, 1961. The idea comes from the OECD/G20 BEPS Action 4 project: multinational groups were loading their Indian company with excessive debt from a foreign group entity, paying out large interest amounts, and shifting taxable profit out of India. Section 177 stops that by putting a ceiling on the interest deduction.

Who it applies to

• Indian companies, and
• Permanent establishments (PEs) of foreign companies operating in India,

that incur interest or similar expenditure of more than ₹1 crore in a tax year, where that expenditure is payable to a non-resident associated enterprise. Two enterprises are "associated enterprises" under the transfer-pricing rules (Section 162) — broadly, one controls the other through 26% or more voting power, common management/control, guarantees, or dependence for finance.

Deemed AE debt: Even a loan from an unrelated lender (like a foreign bank) is caught if a non-resident AE provides an implicit or explicit guarantee for that debt, or deposits a matching amount with the lender. This prevents companies from routing back-to-back loans to dodge the section.

The key limit — 30% of EBITDA

The deductible interest is restricted to the lower of:

• 30% of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) of the business for that year; or
• the actual interest paid or payable to the non-resident AE.

Anything above 30% of EBITDA is treated as "excess interest" and is disallowed for that year — it cannot reduce your taxable business income in the year it is incurred.

Carry forward of disallowed interest

The disallowance is not permanently lost. The excess interest can be carried forward for up to eight (8) tax years immediately following the year of disallowance, and set off against business income in those later years — but only to the extent of the unused 30%-of-EBITDA headroom available in each of those years. If it is not absorbed within eight years, it lapses.

Who is excluded

Because leverage is a normal feature of their business, Section 177 does not apply to Indian companies or PEs engaged in the business of banking or insurance. The Act also carves out certain finance companies located in an International Financial Services Centre (IFSC / GIFT City) and PEs in India of non-resident banks. Domestic (rupee) borrowing from an ordinary unrelated Indian lender with no AE guarantee is also outside the net.

How it interacts with related provisions

• Section 162 (associated enterprises) decides whether the lender is an AE at all — the gateway test.
• Transfer-pricing (Section 161 arm's-length principle) can separately test whether the interest rate is at arm's length; Section 177 then caps the quantum that is deductible.
• Section 34/35 (business deductions) normally allow interest as a business expense — Section 177 overrides this to the extent of the excess.
• GAAR and secondary-adjustment rules can apply alongside if the debt structure is abusive.

Practical implications

• Group treasury teams must model interest against projected EBITDA before deciding the debt level of the Indian entity — a loss-making or low-EBITDA year can disallow almost all AE interest.
• The ₹1 crore threshold is a trigger, not an exemption band: once total AE interest crosses ₹1 crore, the 30% cap is tested on the whole amount, not just the portion above ₹1 crore.
• Disallowed interest still has value — track the carry-forward pool carefully so it is not wasted before the 8-year window closes.