TO inhibit companies from claiming huge tax deductions on interest payments, the Indian government may introduce thin capitalization rules to provide a speed breaker to tax avoidance. It is gathered that a Committee, set up by the CBDT, has been working on the mandate to make recommendations in this regard.

Thin capitalization is when a company brings in a higher proportion of funds through debt rather than equity to claim tax deductions on interest payments, for calculation of taxable profits. Bringing in funds through debt is therefore more advantageous as dividends are paid post tax.

In India, the Foreign Investment Promotion Board (FIPB) defines the debt to equity ratio limit for the automatic investment route in various sectors. But companies can always increase the debt ratio after FIPB approval. This does not apply to domestic companies.

Countries in Europe, US, Russia and China already have thin capitalization norms. Most of these countries define the maximum permissible debt to equity ratio beyond which excess interest payments would not be allowed as a deduction. Alternately, a penalty could be imposed or the interest would be reclassified as debt. Some of the countries also limit the amount of interest a company can claim as a tax deduction.