Interest Tax Rate Between India and Hong Kong Under DTAA

Interest Tax Rate Between India and Hong Kong

Article 11 of the India-Hong Kong Double Taxation Avoidance Agreement (DTAA), signed on March 19, 2018, and in force from November 30, 2018, governs the taxation of interest income flowing between India and Hong Kong. The treaty provides a reduced withholding tax rate of 10% compared to India's domestic rate of 20% (plus applicable surcharge and 4% health and education cess) under Section 195 of the Income Tax Act, 1961.

The 50% reduction in withholding tax is a significant benefit for cross-border lending, intercompany financing, External Commercial Borrowings (ECBs), bond investments, and NRO deposit interest between India and Hong Kong. Given Hong Kong's role as a major international financial centre and a gateway for investment into and out of India, the interest provisions of this treaty are heavily utilized by banks, financial institutions, and corporate groups operating across the India-Hong Kong corridor.

As a modern treaty aligned with the BEPS framework, the India-Hong Kong DTAA embeds anti-avoidance provisions directly within the interest article. The MLI adds the Principal Purpose Test (PPT) as a supplementary safeguard against treaty abuse, with effect for this treaty from April 1, 2023.

Treaty Rate vs Domestic Rate: Detailed Comparison

Article 11 of the India-Hong Kong DTAA establishes a clear, two-tier rate structure:

10% Rate for General Interest

Under Article 11(2), interest arising in one contracting party and paid to a resident of the other party who is the beneficial owner may be taxed in the source country, but the withholding tax shall not exceed 10% of the gross amount. This rate applies to all categories of interest income, including:

• Interest on corporate loans from Hong Kong banks and financial institutions
• Interest on intercompany loans between related entities
• Interest on External Commercial Borrowings (ECBs) from Hong Kong lenders
• Interest on corporate bonds and debentures
• Interest on NRO fixed deposits and savings accounts for Hong Kong-resident NRIs
• Interest on listed and unlisted debt securities

0% Rate for Government and Central Bank Interest

Under Article 11(3), interest is completely exempt from source-country taxation when paid to or received by:

• The Government of either contracting party, including political subdivisions and local authorities
• The Reserve Bank of India
• The Hong Kong Monetary Authority (HKMA)
• Other designated organisations as may be agreed upon between the competent authorities

This exemption facilitates sovereign and quasi-sovereign lending and investment between the two jurisdictions.

Who Qualifies for the Reduced Rate

The reduced 10% rate under Article 11 is available when specific conditions are satisfied:

Beneficial Ownership Requirement

The interest must be beneficially owned by a resident of the other contracting party. The beneficial owner must have the legal and economic right to use, enjoy, and dispose of the interest income independently. Back-to-back loan structures, conduit arrangements, and nominee arrangements do not qualify. Hong Kong entities that merely receive interest and pass it on to third-country principals are not beneficial owners.

GAAR Provisions in Article 11

Like the dividend article, the India-Hong Kong DTAA includes anti-avoidance provisions directly within Article 11. These deny treaty benefits where the principal purpose of an arrangement is to obtain the reduced 10% rate. This is a treaty-level GAAR that operates independently of India's domestic GAAR.

Principal Purpose Test (PPT)

The MLI PPT, which has effect for the India-Hong Kong treaty from April 1, 2023, provides an additional layer of anti-avoidance scrutiny. If obtaining the DTAA benefit was one of the principal purposes of the lending arrangement, the 10% rate may be denied and the domestic rate of 20% (plus surcharge and cess) applied instead.

Arm's Length Requirement

Under Article 11(7), where the amount of interest paid exceeds the arm's length amount due to a special relationship between the payer and the beneficial owner, only the arm's length portion qualifies for the 10% treaty rate. The excess is taxed under domestic law. This provision targets inflated interest payments in related-party transfer pricing arrangements.

Interest-Specific Treaty Provisions

Source Rules for Interest (Article 11(6))

Interest is deemed to arise in a contracting party when the payer is the Government, a political subdivision, a local authority, or a resident of that party. If the payer has a permanent establishment in a contracting party and the debt obligation was incurred in connection with that PE, the interest is deemed to arise in the party where the PE is situated, regardless of the payer's residence.

PE Attribution (Article 11(5))

If the beneficial owner carries on business through a PE in the source country and the debt-claim generating the interest is effectively connected with that PE, the interest is taxed as business profits under Article 7 rather than under Article 11. This means interest attributable to a Hong Kong entity's PE in India is taxed at the applicable corporate tax rate, not the 10% withholding rate.

Definition of Interest

Under Article 11(4), the term "interest" means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and includes income from government securities, bonds, and debentures, as well as premiums and prizes attaching to such instruments. Penalty charges for late payment are expressly excluded from the definition of interest under this Article.

Hong Kong's Domestic Position

Hong Kong does not impose withholding tax on interest payments under its domestic tax law. This means interest paid from Hong Kong to India does not attract Hong Kong withholding tax. However, interest income sourced from Hong Kong may be subject to Hong Kong profits tax if the recipient carries on a trade, profession, or business in Hong Kong.

Documentation Required

To claim the 10% DTAA rate on interest, the following documentation is mandatory:

Tax Residency Certificate (TRC)

The Hong Kong resident must obtain a Certificate of Resident Status from the Hong Kong Inland Revenue Department (IRD). The TRC is a mandatory prerequisite under Section 90(4) of the Indian Income Tax Act and must cover the period during which the interest income is received.

Form 10F

Form 10F must be filed electronically on India's Income Tax e-filing portal, providing details such as the recipient's status (individual, company, etc.), nationality, tax identification number, period of residential status, and Hong Kong address.

Self-Declaration

A self-declaration confirming beneficial ownership, the absence of a permanent establishment in India, the arm's length nature of the interest, and that the arrangement does not have treaty benefit as its principal purpose is typically required.

Bank-Specific Documentation

For Hong Kong banks lending to Indian borrowers, additional documentation may include the banking licence from the HKMA, evidence of regulated banking status, and confirmation that the loan is part of the bank's regular banking business.

Withholding Procedure for Indian Payers

Indian entities paying interest to Hong Kong residents must comply with Section 195 of the Income Tax Act:

TDS Deduction at 10%

The Indian payer deducts TDS at 10% flat (no surcharge or cess) on the gross interest amount at the time of credit or payment, whichever is earlier. The TDS must be deposited with the government by the 7th of the following month.

Form 15CA and Form 15CB

For interest remittances to Hong Kong:

• Form 15CB: A Chartered Accountant must file Form 15CB on the Income Tax portal, certifying the TDS rate, the applicable DTAA provision (Article 11(2)), and that treaty conditions are satisfied
• Form 15CA Part C: The remitter files Form 15CA Part C online, referencing the 15CB acknowledgement
• For remittances up to INR 5 lakh: Only Form 15CA Part A is required

Lower Withholding Certificate (Section 197)

A Hong Kong resident expecting regular interest income from India can apply for a lower withholding certificate under Section 197. The Assessing Officer issues a certificate specifying the TDS rate based on the DTAA provisions and the recipient's overall tax liability.

RBI/FEMA Compliance for ECBs

External Commercial Borrowings from Hong Kong lenders must comply with FEMA regulations and RBI guidelines regarding eligible borrowers, recognised lenders, all-in-cost ceilings, end-use restrictions, and reporting requirements (ECB-2 returns). The DTAA withholding rate does not override RBI's regulatory requirements.

Common Disputes and Judicial Precedents

Beneficial Ownership in Lending Structures

Indian tax authorities have scrutinised lending structures where a Hong Kong entity borrows funds from a third-country entity and on-lends to India. If the Hong Kong entity acts as a mere conduit with no independent discretion over the interest income, the 10% treaty rate may be denied. The entity must demonstrate genuine lending activity, independent credit risk assessment, and economic substance in Hong Kong.

Transfer Pricing on Intercompany Loans

Where related Indian and Hong Kong entities engage in intercompany lending, Indian transfer pricing officers may challenge the interest rate. Under Article 11(7), only the arm's length portion of interest qualifies for the treaty rate. Maintaining contemporaneous benchmarking studies using comparable uncontrolled pricing (CUP) or other methods is essential.

Interest vs Fees Characterisation

Disputes arise over whether certain payments constitute "interest" under Article 11 or "fees for technical services" under Article 13. Guarantee fees, commitment fees, arrangement fees, and processing charges on loans have been the subject of conflicting ITAT rulings. The characterisation affects both the applicable treaty article and the withholding rate (10% in both cases under this treaty, but the conditions differ).

GAAR and PPT Application

The treaty's built-in GAAR provisions, combined with the MLI PPT and India's domestic GAAR, create a robust anti-avoidance framework. CBDT Circular No. 01/2025 has provided guidance on PPT application, clarifying that the test focuses on whether obtaining the treaty benefit was one of the principal purposes, not the sole purpose, of the arrangement. Genuine commercial lending with substance is generally protected.

Practical Examples and Calculations

Example 1: Hong Kong Bank Lending to Indian Company

A Hong Kong bank (regulated by HKMA) extends a USD 20 million term loan to an Indian company at 5% annual interest. Annual interest payment: USD 1,000,000.

• Domestic rate: 20% = USD 200,000 (plus surcharge and cess, effective ~USD 218,400)
• DTAA rate (Article 11(2)): 10% = USD 100,000
• Tax saving under DTAA: USD 100,000 per year (plus surcharge/cess savings)

The Hong Kong bank provides TRC from the IRD, Form 10F, and beneficial ownership declaration. The Indian company deducts TDS at 10% flat and remits USD 900,000.

Example 2: NRI with NRO Fixed Deposit

A Hong Kong-resident NRI has an NRO fixed deposit of INR 1,00,00,000 (INR 1 crore) with an Indian bank earning 7% interest. Annual interest: INR 7,00,000.

• Domestic rate: 20% = INR 1,40,000 (plus surcharge and cess)
• DTAA rate (Article 11(2)): 10% = INR 70,000
• Tax saving under DTAA: INR 70,000 per year (plus surcharge/cess savings)

The NRI furnishes TRC from the Hong Kong IRD, Form 10F, and self-declaration to the Indian bank. The bank deducts TDS at 10% instead of 20%.

Example 3: Intercompany Loan with Transfer Pricing Challenge

A Hong Kong parent company lends HKD 50 million to its Indian subsidiary at 9% interest. Indian TP authorities determine the arm's length rate is 6.5%.

• Interest at stated rate (9%): HKD 4,500,000
• Interest at arm's length rate (6.5%): HKD 3,250,000
• DTAA rate on arm's length portion: 10% of HKD 3,250,000 = HKD 325,000
• Excess portion (2.5%): HKD 1,250,000 - taxed at domestic rate and potentially disallowed as deduction

The excess interest beyond the arm's length amount does not qualify for the treaty rate under Article 11(7). The Indian subsidiary's deduction for the excess may also be disallowed under Section 92 of the Income Tax Act.

Frequently Asked Questions

What is the interest tax rate under the India-Hong Kong DTAA?

The treaty provides a general rate of 10% for all interest payments under Article 11(2). Interest paid to governments and central banks such as the Reserve Bank of India and the Hong Kong Monetary Authority is completely exempt under Article 11(3).

Does the 10% rate apply to NRO fixed deposit interest?

Yes. Interest earned on NRO fixed deposits by Hong Kong-resident NRIs qualifies for the 10% DTAA rate under Article 11(2). The NRI must furnish a TRC from the Hong Kong Inland Revenue Department and Form 10F to the Indian bank.

Does Hong Kong impose withholding tax on interest payments?

No. Hong Kong does not impose withholding tax on interest under its domestic tax law. Interest paid from Hong Kong to India does not attract Hong Kong withholding tax, though it may be subject to Hong Kong profits tax if part of a business carried on in Hong Kong.

What anti-avoidance measures apply to interest claims?

Three layers of anti-avoidance apply: the treaty's own GAAR provisions in Article 11, the MLI Principal Purpose Test effective for this treaty from April 2023, and India's domestic GAAR under Sections 95-102. Back-to-back lending and conduit arrangements are most at risk.

How do transfer pricing rules affect the DTAA rate on interest?

Under Article 11(7), if interest exceeds the arm's length amount due to a special relationship, only the arm's length portion qualifies for the 10% treaty rate. The excess is taxed under domestic law and may also be disallowed as a deduction for the Indian payer.

Is ECB interest from Hong Kong eligible for the 10% rate?

Yes. Interest on External Commercial Borrowings from Hong Kong lenders qualifies for the 10% treaty rate, subject to beneficial ownership, arm's length pricing, and FEMA/RBI compliance. The ECB must also comply with RBI's all-in-cost ceiling and other regulatory requirements.

How do I claim DTAA benefits on interest income from India?

Provide a valid Tax Residency Certificate from the Hong Kong IRD, file Form 10F on India's e-filing portal, and submit a self-declaration of beneficial ownership to the Indian payer. For remittances exceeding INR 5 lakh, Form 15CA and Form 15CB must also be filed.