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Corporates may shun ECB route from June

Janaki Ghatpande

Indian corporates are rushing to tap the overseas market as the external commercial borrowings segment is set to die, following the Centre's decision to withdraw tax exemption under Section 10 (15) IV of the Income Tax Act.

The withdrawal of tax exemption, part of the Finance Bill, will come into effect from next month, making the ECB route more expensive for corporates.

"Despite a very low libor (4.25 per cent), nobody will touch the ECB market from next month as the cost of overseas borrowing will go up by an average 20-25 per cent," said a senior banker.

Reliance Petrochemicals Ltd had last week raised a five-year $750 million facility.

The National Thermal Power Corporation also successfully concluded a $120 million re-finance facility.

Tisco, Exim Bank and a few other corporates are also planning to raise ECBs before the end of the month. "This is possibly the last batch of corporates to raise ECBs as the cost of borrowing will be a deterrent factor from June," the banker pointed out.

Two years back, the finance ministry tried to withdraw tax exemption but did not succeed in the face of stiff resistance from corporates. This time around, it has gone ahead despite several representations made by industry bodies.

The logic put forward by the finance ministry for withdrawal of tax exemption is: the interest received by the lender is taxable in the country of his residence and he would get credit for any tax paid in India.

Hence, any exemption from tax liability in the host country does not benefit the lender but only results in reducing India's tax revenues.

The levy of withholding tax-varying between 20-25 per cent depending on the lender's country-will jack up the interest rate as it will be factored in while deciding the ECB cost. The overseas lenders will be paid interest net of tax, which will be deducted by the remitting bank.

In effect, if the withholding tax is 20 per cent, the corporate will be required to pay 7.2 per cent interest on a loan struck at 6 per cent (Libor plus 175 basis points) as the lenders will charge the interest rate net of tax.

"It may be marginally less depending on the tax benefits the lenders enjoy in their countries. But overall, the cost of ECBs will go up substantially discouraging corporates to take this route," said a banker.

However, the route may not dry up totally as mega projects will still require forex funding. "While the tax factor will act as a deterrent keeping the marginal players away, the product will not entirely be discouraged," says Tarun Mehrotri, treasurer, HSBC.

NS Paramsivam, vice-president (forex treasury), Essar group, said: "It is quite unclear as there have been no circular from either tax authorities or the Reserve Bank of India. Despite the interest component having increased, the ECB route will still be utilised, but not with the same readiness."

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