Section 194LD - Income Tax

The Government of India has introduced a new Section 194LD in the Income Tax Act, 1961 to provide

tax deduction at source (TDS) at a concessional rate for interest income earned by a non-resident from government securities or rupee-denominated bonds. Government Securities and Rupee Denominated Bonds are financial instruments with a high financial value which attract various foreign investors to invest in it. Besides the Indian investors, Foreign Institutional Investor (FII) and Foreign Portfolio Investor (FPI) are a major contributor to the capital market of India. Under Section 115AD of the Income Tax Act, 1961, tax is levied on the incomes earned by the Foreign Institutional Investor (FII). The taxability is also applicable on income earned from interest on Government and Rupee denominated securities. The insertion of Section 194LD has enabled the Foreign Institutional Investor to enjoy a lower TDS rate of 5% on the overall interest. This concession will help boost foreign capital into India.

Section 194LD

The text of the section is reproduced below for reference.

194LD. (1) Any person who is responsible for paying to a person being a Foreign Institutional Investor or a Qualified Foreign Investor, any income by way of interest referred to in sub-section (2), shall, at the time of credit of such income to the account of the payee or at the time of payment of such income in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rate of five per cent. (2) The income by way of interest referred to in sub-section (1) shall be the interest payable in respect of investment made by the payee in— (i) a rupee-denominated bond of an Indian company; or (ii) Government security: Provided that the rate of interest in respect of bond referred to in clause, (i) shall not exceed the rate as may be notified by the Central Government in this behalf. Explained: - a) ‘Foreign Institutional Investor’ is a registered institution that invests in a country other than its own. b) ‘Qualified Foreign Investor’ is a subcategory of FII who is a foreign individual, group or association restricted from those countries, which are the members of FATF. c) ‘Rupee-denominated bond’ is a bond issued by an Indian entity in a foreign market where the buying, selling and repayment are expressed in rupees. d) ‘Government security’ is a Government issued bond, which is of low risk. Foreign Institutional Investor (FII) or a qualified foreign investor consider investing in securities to be gainful and thus make investments claiming a security interest on the collateral. The interest payable by the Indian concern or entity to a foreign entity is deducted 5% tax at source and disbursed in terms of rupees.

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Frequently Asked Questions

Common questions about Section 194LD: 5% Tax Deduction on Interest Income.

Section 194LD is a new provision introduced in the Income Tax Act, 1961, which requires a person responsible for paying interest income to a Foreign Institutional Investor (FII) or a Qualified Foreign Investor (QFI) to deduct tax at source (TDS) at a concessional rate of 5% on such income.

Section 194LD applies to interest income earned by FIIs or QFIs on investments made in rupee-denominated bonds issued by Indian companies or in Government securities.

Section 194LD was introduced to provide a lower TDS rate of 5% on interest income earned by FIIs and QFIs, with the aim of boosting foreign capital inflow into India by making such investments more attractive.

A Foreign Institutional Investor (FII) is a registered institution that invests in a country other than its own, such as foreign banks, pension funds, mutual funds, and other asset management companies.

A Qualified Foreign Investor (QFI) is a subcategory of FII, referring to foreign individuals, groups, or associations restricted from those countries which are members of the Financial Action Task Force (FATF).

A rupee-denominated bond is a bond issued by an Indian entity in a foreign market, where the buying, selling, and repayment are expressed in Indian rupees.

A Government security is a bond or debt instrument issued by the Government of India, which is considered low-risk due to the sovereign backing.

The concessional TDS rate of 5% on interest income earned by FIIs and QFIs is lower than the regular tax rates applicable to such income, making it more attractive for foreign investors to invest in Indian securities.

By providing a lower TDS rate on interest income earned by FIIs and QFIs, Section 194LD aims to attract more foreign capital inflow into India, which can contribute to the growth and development of the Indian capital market and overall economy.

The TDS under Section 194LD needs to be deducted by the person responsible for paying the interest income to the FII or QFI, at the time of crediting the income to the payee's account or at the time of payment, whichever is earlier.