Chapter X - Special Provisions Relating to Avoidance of Tax
Section 177
Section 177: limitation on interest deduction (thin capitalisation rule)
Section 177 is India's thin capitalisation rule - it caps how much interest an Indian company or a foreign company's Indian permanent establishment can deduct on debt owed to a non-resident associated enterprise, to stop profits being shifted out as excessive interest.
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This article is for general information. Refer to the Income-tax Act, 2025 as amended by the Finance Act, 2026 and the Taxation and Other Laws (Amendment) Act, 2026 for the official provisions. If you need professional advice for your situation, contact Bizeneed.
Statutory text
Bare law
(1) Irrespective of anything contrary in this Act, any expenditure by way of interest or similar payment in respect of excess interest, as specified in sub-section (4), shall not be deductible in computation of income chargeable under the head “Profits and gains of business or profession”, if,— (a) it is paid or payable by an Indian company or a permanent establishment of a foreign company in India, in respect of any debt issued by an associated enterprise which is a non-resident; and (b) the sum of such expenditure in a tax year exceeds one crore rupees.
(2) Where a lender, not being an associated enterprise, has issued a debt referred to in sub-section (1), such debt shall be deemed to have been issued by an associated enterprise if an associated enterprise has— (a) provided an implicit or explicit guarantee to the lender in respect of such debt; or (b) deposited a corresponding and matching funds with such lender.
(3) The provisions of this section shall not apply to— (a) interest paid in respect of a debt issued by a lender which is a permanent establishment in India of a non-resident engaged in the business of banking; (b) an Indian company or a permanent establishment of a foreign company which is engaged in the business of banking or insurance or a Finance Company located in any International Financial Services Centre, or such class of non-banking financial companies as may be notified by the Central Government in this behalf.
(4) For the purposes of sub-section (1), the expression “excess interest” means the total interest paid or payable in excess of 30% of earnings before interest, taxes, depreciation and amortisation of the borrower in the tax year or the interest paid or payable to associated enterprises for that tax year, whichever is less.
(5) Interest expenditure not wholly deducted against income under the head “Profits and gains of business or profession” for any tax year shall be— (a) carried forward to the following tax year or years; and (b) allowed as a deduction against the profits and gains, if any, of any business or profession carried on by it and assessable for such tax year, to the extent of maximum allowable interest expenditure as per sub-section (4).
(6) The interest expenditure referred to in sub-section (5) shall not be carried forward for more than eight tax years immediately succeeding the tax year for which the excess interest expenditure was first computed.
(7) For the purposes of this section,— (a) “debt” means any loan, financial instrument, finance lease, financial derivative, or any arrangement that gives rise to interest, discounts or other finance charges that are deductible in the computation of income chargeable under the head “Profits and gains of business or profession”; (b) “Finance Company” means a finance company as defined in regulation 2(1)(e) of the International Financial Services Centres Authority (Finance Company) Regulations, 2021 made under the International Financial Services Centres Authority Act, 2019 and which satisfies such conditions and carries on such activities, as may be prescribed; (c) “permanent establishment” shall have the meaning assigned to it in section 173(c).
Introduction
Section 177 limits deduction of excess interest on certain non-resident associated-enterprise debt when an Indian company or an Indian permanent establishment exceeds the ₹1 crore interest threshold. It contains deemed related-party debt, excluded sectors, an EBITDA-based measure and a limited carry-forward.
Key takeaways
Related-party interest cap
Where an Indian company or Indian permanent establishment pays over ₹1 crore of interest on specified non-resident associated-enterprise debt, excess interest is disallowed subject to the stated exclusions.
Limit and carry-forward
Excess interest is measured against 30% of EBITDA or associated-enterprise interest, whichever is less, and a disallowed amount can be carried forward for up to eight succeeding tax years.
The core limitation
Irrespective of anything else in the Act, expenditure by way of interest or similar payment in respect of "excess interest" is not deductible while computing income under "Profits and gains of business or profession", where:
- it is paid or payable by an Indian company or a foreign company's permanent establishment in India, on a debt issued by a non-resident associated enterprise; and
- the total of such expenditure in the tax year exceeds ₹1 crore.
When a debt is deemed issued by an associated enterprise
Where a lender who is not an associated enterprise has issued the debt, that debt is nonetheless deemed to have been issued by an associated enterprise if an associated enterprise has provided an implicit or explicit guarantee to the lender for that debt, or has deposited corresponding and matching funds with the lender.
Exclusions
Section 177 does not apply to:
- interest paid on a debt issued by a lender that is an Indian permanent establishment of a non-resident engaged in the banking business;
- an Indian company, or an Indian permanent establishment of a foreign company, engaged in the business of banking or insurance, or a Finance Company located in an International Financial Services Centre, or such class of non-banking financial companies as the Central Government notifies.
How "excess interest" is calculated
"Excess interest" means the total interest paid or payable in excess of 30% of the borrower's EBITDA (earnings before interest, taxes, depreciation and amortisation) for the tax year, or the interest paid/payable to associated enterprises for that year - whichever is less.
Carry forward of disallowed interest
Interest expenditure not fully deducted in a tax year because of this cap is carried forward to the following year(s), and allowed as a deduction against business profits in those years, up to the maximum allowable interest expenditure for that year as computed under sub-section (4).
This carry-forward is limited to eight tax years immediately succeeding the year in which the excess interest was first computed.
Key definitions
"Debt" means any loan, financial instrument, finance lease, financial derivative, or arrangement giving rise to interest, discounts or other finance charges deductible under "Profits and gains of business or profession". "Finance Company" has the meaning under the IFSCA (Finance Company) Regulations, 2021, subject to prescribed conditions and activities. "Permanent establishment" has the meaning assigned in Section 173(c).
Step-by-step flow for applying Section 177
- 1
Is the borrower an Indian company or an Indian permanent establishment of a foreign company?
- No: Section 177 does not apply.
- Yes: Go to the next step.
- 2
Is it excluded?
Banking or insurance businesses, an IFSC Finance Company, a notified class of NBFCs, or interest on debt from the Indian banking permanent establishment of a non-resident.
- Yes: Section 177 does not apply.
- No: Go to the next step.
- 3
Is the interest on a debt issued (or deemed issued) by a non-resident associated enterprise, and is that interest more than ₹1 crore in the tax year?
A third-party loan is deemed issued by an associated enterprise if the associated enterprise guaranteed it or deposited matching funds with the lender.
- No: No limitation under Section 177.
- Yes: Go to the next step.
- 4
Compute the excess interest
The lower of (a) total interest minus 30% of EBITDA, and (b) interest paid or payable to associated enterprises. That amount is disallowed.
- 5
Carry the disallowed interest forward
It is deductible against business profits in later years within the Section 177(4) limit, for up to eight tax years after the year in which it was first computed.
Practical checklist
Do
- Identify non-resident AE debt, related guarantees or matching deposits, and total annual interest.
- Test the statutory exclusions, compute the excess-interest limit and track any eligible eight-year carry-forward.
Avoid
- Do not assume third-party debt escapes if an AE guarantee or matching funding exists.
- Do not apply the limitation to an exempt sector or below the ₹1 crore trigger without checking the statute.
Illustrative example
Worked example: computing excess interest
Hypothetical facts (illustration only, not a real taxpayer): An Indian company (not a bank, insurer or excluded finance company) has EBITDA of ₹10 crore for the tax year. Its total interest is ₹5 crore, of which ₹4 crore is paid to its non-resident parent on a loan the parent issued.
Threshold
Interest on the associated enterprise debt is ₹4 crore, which exceeds ₹1 crore.
30% of EBITDA
30% × ₹10 crore = ₹3 crore. Total interest above that = ₹5 crore - ₹3 crore = ₹2 crore.
Lower of the two
Compare ₹2 crore with interest to associated enterprises of ₹4 crore. The lower, ₹2 crore, is the excess interest.
Disallowance
₹2 crore is not deductible this year. ₹3 crore of interest is allowed.
Outcome
- The ₹2 crore is carried forward and can be deducted against business profits in later years within the Section 177(4) limit, for up to eight succeeding tax years.
- If the parent's loan had instead been from an unrelated bank that the parent guaranteed, the debt would still be treated as issued by an associated enterprise (Section 177(2)(a)).
Glossary
- Excess interest
- The interest amount disallowed under subsection (4)'s limitation formula.
- EBITDA
- Earnings before interest, tax, depreciation and amortisation used in the limitation calculation.
Frequently asked questions
What is the interest deduction cap under Section 177?
Interest paid/payable to a non-resident associated enterprise in excess of 30% of the borrower's EBITDA for the year (or, if lower, the interest paid/payable to associated enterprises that year) is not deductible, but only where total such expenditure in the year exceeds ₹1 crore.
Can disallowed interest be claimed in a later year?
Yes - it can be carried forward and deducted against business profits in later years, subject to the same annual cap, for up to eight tax years immediately following the year the excess interest was first computed.
Are banks and insurers covered by this cap?
No - Indian companies or Indian permanent establishments engaged in banking or insurance, Finance Companies in an International Financial Services Centre, and notified classes of non-banking financial companies are excluded, as are debts from a non-resident bank's Indian permanent establishment.
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Review your interest deduction position with our tax teamLast updated 10 October 2026