An intercompany loan can be priced at a perfectly defensible arm's length interest rate under conventional transfer pricing analysis and still have a portion of that interest disallowed as a tax deduction, because thin capitalisation and interest limitation rules operate as a separate statutory ceiling layered on top of, not instead of, the arm's length pricing requirement. India's Section 94B, implementing the BEPS Action 4 framework, is the clearest illustration of how the two regimes interact and sometimes collide.
What Section 94B Actually Limits
Section 94B caps the deduction for interest or similar consideration paid or payable to an associated enterprise, or to a third party where an associated enterprise provides an implicit or explicit guarantee, at thirty percent of the borrowing entity's EBITDA, or the actual interest expense, whichever is lower, for Indian companies whose interest expense to an associated enterprise exceeds the prescribed threshold, currently one crore rupees. Interest disallowed in a given year can generally be carried forward and set off against future years' permissible interest deduction limit, subject to a statutory time cap.
Why an Arm's Length Rate Doesn't Guarantee Full Deductibility
The two regimes ask genuinely different questions. Transfer pricing under Section 92 asks whether the interest rate itself reflects what an independent lender would have charged, given the borrower's credit profile and the loan's terms. Section 94B asks a separate, EBITDA-based leverage question entirely: regardless of whether the rate is arm's length, is the borrowing entity's total related-party interest burden proportionate to its earnings capacity. A loan priced at an impeccably benchmarked arm's length rate can still trigger a Section 94B disallowance if the borrower is carrying more related-party debt than its EBITDA can support under the statutory ratio.
The Guarantee Extension
Section 94B's reach extends beyond direct related-party loans to third-party debt that an associated enterprise implicitly or explicitly guarantees, or where a matching deposit or comparable arrangement effectively passes the credit risk of a nominally independent loan back to the group. This anti-avoidance extension means groups cannot simply route related-party financing through an ostensibly third-party lender, backed by a group guarantee, to escape the EBITDA-based cap, a structure the provision was specifically designed to catch.
Interaction with the Loan's Standalone Credit Rating
Because Section 94B's cap operates independently of the loan's arm's length interest rate, groups modelling the true cost of intercompany debt need to run both analyses together: the credit-rating notching and comparable-instrument benchmarking exercise that establishes the arm's length rate under conventional TP methodology, and a separate EBITDA-based leverage test to confirm the resulting interest expense will actually be deductible. A financing structure optimised purely for arm's length rate defensibility, without regard to the borrower's resulting interest-to-EBITDA ratio, can still generate a substantial non-deductible interest cost.
Structuring Around the Limitation
Where a borrowing entity's projected related-party interest burden approaches or exceeds the thirty percent EBITDA threshold, groups typically consider a mix of responses: reducing related-party debt levels in favour of equity or third-party financing not subject to the same guarantee-linked extension, restructuring loan tenor and repayment profiles to smooth the annual interest charge, or accepting the disallowance and tracking the carry-forward against the entity's projected future EBITDA growth. Each option carries its own transfer pricing and commercial trade-offs that need to be modelled against the entity's specific financial trajectory rather than applied as a generic template.
Conclusion
Section 94B operates as an independent statutory overlay on top of conventional interest-rate transfer pricing, not a restatement of it, and a fully defensible arm's length rate provides no protection against an EBITDA-based leverage disallowance. Groups financing Indian subsidiaries through related-party debt should model the interest limitation exposure alongside the credit-rating and rate benchmarking exercise, as a single combined financing analysis, rather than as two sequential and unconnected compliance steps.
