With the introduction of ‘Thin Capitalization’ concept under Union Budget 2017-18, the realty players are expected to see further fall in their profit margins. Under this new rule, interest paid on foreign debt above 30% of their EBITDA (earnings before interest, tax, depreciation and amortisation) cannot be claimed for tax deduction purposes.
Realty Sector was already struggling with the shrinking profit margins over last few years and the situation was worsened with the announcement of demonetization. Infrastructure companies with large chunk of international debt at project level or in their special purpose vehicles (SPVs) are expected to bear the brunt majorly with this new announcement under budget.
Investment through non-convertible debentures and the interest paid on them are also expected to be considered as debt investments by government. By April 2017, this ‘new’ concept shall come into effect in line with the Base Erosion and Profit Shifting (BEPS) framework. BEPS framework is basically a global agreement where 15 action points are taken care of in order to check tax avoidance by multinationals.
With thin profit margins, infrastructure segment was getting most of its debt investment through Cyprus. But effective April 2017, an additional tax shall be levied on all investments coming within country through Cyprus as the government renegotiated the treaty with Cyprus in 2016.
Infrastructure and real estate companies were highly leveraged as they receive significant funding from off-shore parties and benefited with the interest payments made to subsidiaries or SPVs in the form of tax deductions. Now under the new scheme, this tax deduction has been restricted to the 30% of EBITDA (profit before any deductions).
Hence, this scheme will bring down the profit margins in realty segment but it is expected that the companies with higher profit margins will recover this within a couple of years. They will carry forward the unabsorbed interest.
