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, in force from November 30, 2018 and effective in India for fiscal years beginning on or after April 1, 2019, 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 393(2) of the Income-tax Act, 2025 (Table, Sl. No. 17; 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 negotiated after the BEPS project, the India-Hong Kong DTAA embeds its anti-avoidance rule directly within the interest article: Article 11(8) withdraws the benefits of the Article where the main purpose, or one of the main purposes, of any person concerned with the creation or assignment of the debt-claim was to take advantage of it. The treaty is not a Covered Tax Agreement under the Multilateral Instrument (MLI) — India did not notify the Hong Kong agreement — so the MLI Principal Purpose Test does not apply to it; the built-in main-purpose tests carried by Articles 10 to 14 do that work instead.

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 arising in one contracting party is exempt from tax in that party provided it is derived and beneficially owned by one of the following. This is a recipient-side test only — the identity of the payer is irrelevant:

• The Government of the other contracting party, a political subdivision or a local authority of it
• In the case of India, the Reserve Bank of India and the Export-Import Bank of India
• In the case of Hong Kong, the Hong Kong Monetary Authority (HKMA) and the Exchange Fund
• Any other institution as may be agreed upon from time to time between the competent authorities

This exemption facilitates sovereign and quasi-sovereign lending and investment between the two jurisdictions. Two limits are worth noting: interest does not become exempt merely because a government is the payer, and the treaty contains no separate reduced tier for banks or other financial institutions — commercial bank lending sits at the ordinary 10% cap.

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.

Built-in Anti-Avoidance Clause (Article 11(8))

Like the dividend article, the India-Hong Kong DTAA carries its anti-avoidance rule inside the interest article itself. Article 11(8) provides that the benefits of the Article are not available if the main purpose, or one of the main purposes, of any person concerned with the creation or assignment of the debt-claim on which the interest is paid was to take advantage of the Article. This treaty-level test operates independently of India's domestic GAAR.

No MLI Principal Purpose Test

India did not notify the Hong Kong agreement as a Covered Tax Agreement under the MLI, so the MLI Principal Purpose Test does not apply to this treaty. Anti-abuse scrutiny runs through the built-in main-purpose test in Article 11(8) and India's domestic GAAR instead. Where either applies, the 10% rate may be denied and the domestic rate of 20% (plus surcharge and cess) applied to the interest 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 a resident of that party. Where the payer, whether or not a resident of a contracting party, has a permanent establishment or fixed base in a contracting party in connection with which the indebtedness was incurred, and the interest is borne by that permanent establishment or fixed base, the interest is deemed to arise in the party where the PE or fixed base 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 — or performs independent personal services there from a fixed base — and the debt-claim generating the interest is effectively connected with that PE or fixed base, the interest is taxed under Article 7 as business profits (or under Article 15 for independent personal services) 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 159(8) of the Income-tax Act, 2025 (section 90(4) of the Income-tax Act, 1961) and must cover the period during which the interest income is received.

Form 41 (formerly Form 10F)

Form 41 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 393(2) of the Income-tax Act, 2025:

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.

Forms 145 and 146 (formerly Forms 15CA and 15CB)

For interest remittances to Hong Kong:

• Form 146: A Chartered Accountant must file Form 146 on the Income Tax portal, certifying the TDS rate, the applicable DTAA provision (Article 11(2)), and that treaty conditions are satisfied
• Form 145 Part C: The remitter files Form 145 Part C online, referencing the Form 146 acknowledgement
• For remittances up to INR 5 lakh: Only Form 145 Part A is required

Lower Withholding Certificate (Section 395(1))

A Hong Kong resident expecting regular interest income from India can apply for a lower withholding certificate under section 395(1) of the Income-tax Act, 2025 (section 197 of the Income-tax Act, 1961). 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 governing eligible borrowers, recognised lenders, pricing, end-use restrictions, and reporting. Under Notification FEMA 3(R)(5)/2026-RB (in force 16 February 2026), which substituted Schedule I of the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018, there is no all-in-cost ceiling for ECB with an average maturity of three years or more — pricing is in line with prevailing market conditions — while ECB with an average maturity below three years must stay within the Trade Credit ceiling of benchmark rate + 300 bps (foreign currency ECB) or + 250 bps (rupee ECB). The minimum average maturity is three years, and the Form ECB-2 return must be filed through the designated AD Category-I bank within seven calendar days from the end of the month in which proceeds were received or debt servicing was undertaken. The DTAA withholding rate does not override these 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).

Main-Purpose Test and GAAR Application

The treaty's built-in main-purpose test in Article 11(8), combined with India's domestic GAAR in sections 178 to 184 of the Income-tax Act, 2025 (sections 95 to 102 of the Income-tax Act, 1961), creates a robust anti-avoidance framework — with no MLI overlay, since India did not notify this agreement under the MLI. The Article 11(8) test turns on whether taking advantage of the Article was the main purpose, or one of the main purposes, of the person concerned with creating or assigning the debt-claim; it does not require that to be the sole purpose. 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 41, 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: 30% = INR 2,10,000 (plus surcharge and cess) — rupee NRO deposit interest falls outside the 20% rate in section 207(1) (Table, Sl. Nos. 1-3) of the Income-tax Act, 2025 (section 115A of the Income-tax Act, 1961), which is confined to interest on foreign-currency borrowings, so the bank withholds at 30% under section 393(2)
• DTAA rate (Article 11(2)): 10% = INR 70,000
• Tax saving under DTAA: INR 1,40,000 per year (plus surcharge/cess savings)

The NRI furnishes TRC from the Hong Kong IRD, Form 41, and self-declaration to the Indian bank. The bank deducts TDS at 10% instead of 30%.

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 161 of the Income-tax Act, 2025 (section 92 of the Income-tax Act, 1961).

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 derived and beneficially owned by the two governments, by the Reserve Bank of India or the Export-Import Bank of India, or by the Hong Kong Monetary Authority or the Exchange Fund, is 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 41 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?

Two layers of anti-avoidance apply: the treaty's own main-purpose test in Article 11(8), and India's domestic GAAR in sections 178 to 184 of the Income-tax Act, 2025 (sections 95 to 102 of the Income-tax Act, 1961). The treaty is not covered by the MLI, so the MLI Principal Purpose Test does not apply to it. 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 meet the FEMA borrowing conditions: a minimum average maturity of three years, market-based pricing with no all-in-cost ceiling at that maturity (only sub-three-year ECB is capped, at benchmark rate + 300 bps for foreign currency or + 250 bps for rupee), and Form ECB-2 reporting through the designated AD Category-I bank within seven calendar days from the end of the month.

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

Provide a valid Tax Residency Certificate from the Hong Kong IRD, file Form 41 on India's e-filing portal, and submit a self-declaration of beneficial ownership to the Indian payer. For remittances exceeding INR 5 lakh, Forms 145 and 146 must also be filed.