Thin Capitalisation Rules: Limit on Interest Deduction under the Income Tax Act 2025 (Section 177)

Section 177 of the Income-tax Act, 2025 limits the business deduction for interest that an Indian company, or the Indian permanent establishment of a foreign company, pays on debt from a non-resident associated enterprise. It applies when that interest is more than Rs 1 crore in a tax year. The disallowed part is the "excess interest": the total interest above 30% of the borrower's EBITDA, or the interest paid to associated enterprises, whichever is less. Disallowed interest can be carried forward for up to eight tax years.

This is the thin capitalisation (or interest limitation) rule. It stops a business from being funded mostly by debt from a foreign group company and then deducting heavy interest against Indian profits. Every figure below comes from section 177 of the Act (as amended by the Finance Act, 2026) and rule 126 of the Income-tax Rules, 2026. I have not mapped this section to any section of the 1961 Act, so check that mapping separately if you need it. Last reviewed against the text on 10 November 2026.

What does section 177 of the Income Tax Act 2025 say?

Section 177(1) says that, irrespective of anything else in the Act, "excess interest" is not deductible in computing business or professional income if both of these are true:

• the interest or similar payment is paid or payable by an Indian company or a permanent establishment of a foreign company in India, on debt issued by a non-resident associated enterprise; and
• the total of such expenditure in the tax year exceeds Rs 1 crore.

"Associated enterprise" and "permanent establishment" come from the transfer pricing provisions. For this section, a permanent establishment has the meaning in section 173(c), which includes a fixed place of business through which the enterprise's business is wholly or partly carried on.

How is excess interest calculated?

Section 177(4) defines excess interest as the lower of two amounts:

1. total interest paid or payable in the tax year, minus 30% of the borrower's EBITDA (earnings before interest, taxes, depreciation and amortisation) for the year; and
2. the interest paid or payable to associated enterprises for that tax year.

I read the first limb as "total interest less 30% of EBITDA", which is how the worked examples below treat it. The Act does not define EBITDA in section 177, so the computation base should be settled with your advisor.

When is a loan from a third-party lender treated as associated-enterprise debt?

Section 177(2) closes a back door. If the lender is not itself an associated enterprise, the debt is deemed to be issued by an associated enterprise when an associated enterprise has either:

• given an implicit or explicit guarantee to the lender for that debt; or
• deposited corresponding and matching funds with that lender.

So a parent that guarantees a foreign bank loan to its Indian subsidiary, or keeps a matching deposit with the bank, brings that loan within the section.

Who is exempt from the thin capitalisation limit?

Section 177(3) says the section does not apply to:

• interest on a debt issued by a lender that is the Indian permanent establishment of a non-resident engaged in banking;
• an Indian company or a foreign company's Indian PE engaged in banking or insurance;
• a Finance Company located in an International Financial Services Centre (IFSC); and
• such class of non-banking financial companies as the Central Government notifies.

For the IFSC finance company, section 177(7)(b) points to conditions in the Rules. Rule 126(1) says it may carry on only these activities: lending (loans, commitments, guarantees, credit enhancement, securitisation, financial lease); factoring and forfaiting of receivables; or the functions of a Global or Regional Corporate Treasury Centre. Under rule 126(2), the interest it pays on debt issued by a non-resident must be in foreign currency. I did not verify the notification list of NBFCs, so check the Government notifications for that class.

What counts as "debt" under section 177?

Section 177(7)(a) gives a wide meaning. Debt is any loan, financial instrument, finance lease, financial derivative, or any arrangement that gives rise to interest, discounts or other finance charges that are deductible under the head "Profits and gains of business or profession". It is not limited to a plain term loan.

Does section 177 apply to firms, LLPs or loans from Indian lenders?

Section 177(1)(a) names only two borrowers: an Indian company, and the Indian permanent establishment of a foreign company. It also needs the debt to be issued by an associated enterprise that is a non-resident. A loan from a resident group company is therefore outside the text, unless section 177(2) deems it to be associated-enterprise debt through a guarantee or matching deposit. The disallowance applies "irrespective of anything contrary in this Act", so it overrides the general interest deduction under business income.

Can disallowed interest be carried forward?

Yes. Under section 177(5), interest not wholly deducted in a tax year is carried forward to later years and allowed against business profits of those years, to the extent of the maximum allowable interest under sub-section (4). Under section 177(6), it cannot be carried forward for more than eight tax years after the year in which the excess interest was first computed.

Worked examples (tax year 2026-27)

Example 1: total interest is the binding limit

Assumptions: Indian company, no banking or insurance business. EBITDA is Rs 40 crore. Total interest is Rs 15 crore, of which Rs 6 crore is paid to a non-resident parent.

Step	Working	Rs crore
1. Section applies?	Interest to associated enterprise 6 is above 1	Yes
2. 30% of EBITDA	30% x 40	12
3. Total interest less 30% of EBITDA	15 - 12	3
4. Interest to associated enterprises	Given	6
5. Excess interest	Lower of 3 and 6	3
6. Deductible interest	15 - 3	12

Rs 3 crore is disallowed in 2026-27 and can be carried forward under section 177(5).

Example 2: associated-enterprise interest is the binding limit

Assumptions: EBITDA is Rs 30 crore. Total interest is Rs 20 crore, of which Rs 5 crore is paid to a non-resident group company.

Step	Working	Rs crore
1. 30% of EBITDA	30% x 30	9
2. Total interest less 30% of EBITDA	20 - 9	11
3. Interest to associated enterprises	Given	5
4. Excess interest	Lower of 11 and 5	5
5. Deductible interest	20 - 5	15

Only Rs 5 crore is disallowed, because the section reaches no more than what was paid to associated enterprises. The Rs 6 crore of excess over the 30% line that was not paid to associated enterprises is not hit by this section.

Example 3: below the Rs 1 crore trigger

A company pays Rs 80 lakh of interest to its non-resident parent in the year. Section 177(1)(b) needs the expenditure to exceed Rs 1 crore, so section 177 does not apply, whatever the EBITDA.

Real-life scenarios

Meena's manufacturing company. Meena runs an Indian subsidiary that borrows from a Singapore bank. The foreign parent gives the bank a guarantee. The bank is not an associated enterprise, but under section 177(2)(a) the loan is treated as associated-enterprise debt, so the interest counts toward the Rs 1 crore test and the excess interest calculation.

Ravi's lending business. Ravi's Indian NBFC borrows from an overseas affiliate. Whether section 177 applies depends on whether it falls in the class of NBFCs the Central Government has notified under section 177(3)(b). If it does not, the ordinary calculation applies. He should confirm this before filing.

A carry-forward case. A company has Rs 3 crore of excess interest in 2026-27 (as in Example 1). In 2027-28, its allowed interest limit leaves headroom. Section 177(5) lets it claim the carried-forward amount against business profits to the extent of the maximum allowable interest under sub-section (4), and the claim must be made within eight tax years after 2026-27.

What are the common mistakes with section 177?

• Ignoring guaranteed loans. A bank loan with a parent guarantee or matching deposit is deemed associated-enterprise debt (section 177(2)).
• Checking only term loans. "Debt" includes financial instruments, finance leases and derivatives that produce deductible finance charges (section 177(7)(a)).
• Forgetting the Rs 1 crore test. The trigger is on the total of such expenditure for the year, not per loan.
• Letting carry-forward lapse. The eight-year clock starts after the year of first computation (section 177(6)).
• Assuming every financial company is exempt. The exemption is limited to the categories in section 177(3).

Quick reference

Item	Rule	Where
Who is covered	Indian company or PE of a foreign company in India	177(1)(a)
Lender	Non-resident associated enterprise, or deemed via guarantee or matching funds	177(1)(a), 177(2)
Trigger	Interest above Rs 1 crore in the tax year	177(1)(b)
Cap	30% of EBITDA	177(4)
Carry forward	Up to 8 tax years	177(5), (6)
IFSC finance company conditions	Permitted activities; interest to non-resident in foreign currency	Rule 126

Where this is in the Act

• Section 177(1): disallowance and the Rs 1 crore trigger
• Section 177(2): guarantee and matching-funds deeming rule
• Section 177(3): exemptions
• Section 177(4): excess interest formula
• Section 177(5), (6): carry forward, eight tax years
• Section 177(7): definitions of debt, Finance Company, permanent establishment
• Section 173(c): meaning of permanent establishment
• Rule 126: conditions and activities for an IFSC finance company

Related reading: transfer pricing and arm's length price under the 2025 Act.

How do CA firms keep track of this?

For a CA firm, the hard part is knowing which clients have foreign-group borrowing, when the carry-forward years run out, and which filings are due. Finexo's practice management software tracks these deadlines across your client book. It does not compute the interest limit for you.

This article explains the Income-tax Act, 2025 (as amended by the Finance Act, 2026) and the Income-tax Rules, 2026. It is general information, not tax advice. Confirm the position for a specific case with a qualified chartered accountant.