Interest Tax Rate Between India and Saudi Arabia Under DTAA

Interest Tax Rate Between India and Saudi Arabia

The India-Saudi Arabia Double Taxation Avoidance Agreement (DTAA), signed at New Delhi on 25 January 2006 and effective from 1 November 2006, provides a reduced withholding tax rate on cross-border interest payments between the two countries. Under Article 11(2) of the treaty, income from debt-claims arising in one Contracting State and paid to a beneficial owner who is a resident of the other Contracting State may be taxed, but the tax so charged shall not exceed 10% of the gross amount. This compares favourably with India's domestic withholding rate of 20% (plus applicable surcharge and cess) on interest paid to non-residents under Section 195 read with Section 115A of the Income Tax Act, 1961.

A distinctive feature of the India-Saudi Arabia DTAA is that Article 11 uses the term "income from debt-claims" rather than the more common term "interest" used in most other Indian DTAAs. While the substance is identical, this terminological difference reflects the treaty's sensitivity to Islamic finance principles, where the concept of "interest" (riba) carries particular religious significance in Saudi Arabia. In practice, both conventional interest and Sharia-compliant financing returns are covered by this article.

Treaty Rate vs Domestic Rate: Detailed Comparison

Understanding the tax savings available under the DTAA is essential for cross-border financial planning between India and Saudi Arabia:

Under Section 115A of the Income Tax Act, the standard domestic withholding rate on interest paid to non-residents on foreign currency borrowings is 20%. With surcharge and health and education cess, the effective rate can reach approximately 22.88%. However, concessional domestic rates of 5% apply to certain categories such as infrastructure debt fund interest (Section 194LB) and Masala bond interest under Section 194LC (for monies borrowed or bonds issued before 1 July 2023). For these categories, the domestic rate is lower than the DTAA rate, and Section 90(2) allows the taxpayer to apply the more beneficial rate.

For NRIs in Saudi Arabia holding NRE or FCNR deposits, the interest is generally exempt from Indian tax under Section 10(4)(ii) (NRE) or Section 10(15)(iv)(fa) (FCNR) as long as the NRI status is maintained, making the DTAA provisions less relevant for these specific deposit types.

Who Qualifies for the Reduced Rate

The reduced 10% withholding rate under the India-Saudi Arabia DTAA is available to recipients meeting the following conditions:

Beneficial Ownership

Article 11(2) requires the recipient to be the beneficial owner of the income from debt-claims. The beneficial owner must have the genuine economic right to use and enjoy the interest income without being legally or contractually obligated to pass it on to another person. Conduit arrangements, back-to-back loans through Saudi intermediaries, and nominee structures will not qualify.

Tax Residency in Saudi Arabia

The recipient must be a tax resident of Saudi Arabia under Article 4 of the DTAA. A valid Tax Residency Certificate (TRC) from the Zakat, Tax and Customs Authority (ZATCA) of Saudi Arabia is required. Saudi Arabia issues TRCs to entities subject to its corporate income tax or Zakat jurisdiction, as well as to individuals who are residents under Saudi law.

Anti-Avoidance: MLI and GAAR

Both India and Saudi Arabia have signed and ratified the Multilateral Instrument (MLI). The Principal Purpose Test (PPT) under the MLI now applies to the India-Saudi Arabia DTAA, allowing denial of the 10% rate if obtaining treaty benefits was one of the principal purposes of a financing arrangement. India's GAAR (Chapter X-A of the Income Tax Act) provides additional anti-avoidance safeguards. Saudi Arabia signed the MLI on 18 September 2018 and deposited its ratification on 23 January 2020, with the MLI entering into force on 1 May 2020.

Permanent Establishment Exception

Under Article 11(5), the 10% cap does not apply if the beneficial owner carries on business in India through a Permanent Establishment (PE) and the debt-claim giving rise to the interest is effectively connected with that PE. In such cases, the income from debt-claims is treated as business profits under Article 7 and taxed accordingly.

Interest-Specific Treaty Provisions

Article 11 of the India-Saudi Arabia DTAA contains several noteworthy provisions:

Definition: "Income from Debt-Claims"

Article 11(4) defines "income from debt-claims" to include 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. The treaty notably avoids using the term "interest" in the article heading, instead using "Income from Debt-Claims" — a formulation that accommodates Islamic finance structures where conventional interest may be recharacterized as profit-sharing or lease payments.

Source Rule

Income from debt-claims is deemed to arise in a Contracting State when the payer is a resident of that State. Where the person paying has a PE in a State and the debt-claim is borne by that PE, the income is deemed to arise in the State of the PE, regardless of the payer's residence.

Arm's Length Limitation

Article 11(7) provides that where the amount of income from debt-claims exceeds the arm's length amount due to a special relationship between the payer and the beneficial owner, the treaty provisions apply only to the arm's length portion. The excess remains taxable under the domestic laws of each State.

Sharia-Compliant Financing

Given Saudi Arabia's Islamic finance industry, the treaty's "income from debt-claims" terminology is particularly significant. Returns from Sharia-compliant instruments such as Murabaha (cost-plus financing), Ijara (lease financing), Sukuk (Islamic bonds), and Mudarabah (profit-sharing) may qualify under Article 11, provided the economic substance of the arrangement constitutes income from debt-claims. Indian tax authorities may examine the substance of such arrangements to determine whether they fall under Article 11 or are more appropriately classified under other treaty articles.

Documentation Required

Saudi entities and individuals receiving interest from Indian sources must furnish the following documents to claim the reduced 10% rate:

Tax Residency Certificate (TRC)

A valid TRC issued by ZATCA for the relevant financial year, as mandated under Section 90(4) of the Indian Income Tax Act. ZATCA issues TRCs to entities registered under the Saudi tax or Zakat system and to qualifying individual residents.

Form 10F

Form 10F is a self-declaration providing the taxpayer's details including status, nationality, Saudi tax identification number, period of residential status, and Saudi address. Form 10F must be filed electronically on the Indian income tax portal since 2022.

No Permanent Establishment Declaration

A declaration confirming that the Saudi recipient does not have a PE in India, or that the debt-claim giving rise to the interest income is not effectively connected with any PE in India.

Beneficial Ownership Declaration

A self-declaration that the Saudi entity or individual is the beneficial owner of the income from debt-claims and is not acting as a nominee, agent, or conduit for a third party.

Withholding Procedure for Indian Payers

Indian entities making interest payments to Saudi residents must comply with the following procedures:

Section 195 Compliance

Under Section 195, any person responsible for paying income to a non-resident (including income from debt-claims) must deduct tax at source. The payer may apply the DTAA rate of 10% instead of the domestic rate of 20% when the Saudi recipient has provided valid TRC, Form 10F, and required declarations.

Form 15CA and Form 15CB

Before making any cross-border remittance of interest, the Indian payer must:

• Obtain Form 15CB from a Chartered Accountant certifying the nature of the payment, applicable DTAA article, and rate of withholding
• File Form 15CA electronically on the Income Tax portal as a declaration to the authorized dealer bank

These forms must be completed before the remittance is processed. Non-compliance can result in penalties under Section 271-I of the Income Tax Act (up to INR 1 lakh per default).

Lower Withholding Certificate (Section 197)

The payer or payee may apply for a lower withholding certificate under Section 197 if the actual tax liability is expected to be lower. This is particularly relevant for Saudi banks and financial institutions with recurring interest receipts from Indian borrowers.

Common Disputes and Judicial Precedents

Classification of Islamic Finance Returns

A significant interpretive challenge involves whether returns from Sharia-compliant financing arrangements qualify as "income from debt-claims" under Article 11 or should be classified differently (e.g., as business profits under Article 7 or as rental income). Indian tribunals have not yet issued definitive rulings on this specific question under the India-Saudi Arabia DTAA, though the broad definition in Article 11(4) generally supports including such returns.

Interest vs. Fees for Technical Services

Since the India-Saudi Arabia DTAA does not contain a separate FTS article, there is no risk of interest being reclassified as FTS. However, complex financial arrangements involving advisory or management components may lead to disputes about whether the payment is interest under Article 11 or business profits under Article 7.

NRI Deposits and Treaty Benefits

NRIs in Saudi Arabia earning interest from Indian bank deposits face specific considerations. While NRE and FCNR deposit interest is typically exempt under Sections 10(4)(ii) and 10(15)(iv)(fa) respectively, interest from NRO deposits is taxable. Such NRIs can claim the 10% DTAA rate on NRO interest instead of the domestic rate of approximately 31.2% (for individuals in the highest bracket).

Transfer Pricing on Intercompany Financing

Interest on loans between associated enterprises (e.g., Indian subsidiary borrowing from Saudi parent) is subject to transfer pricing scrutiny under Chapter X of the Income Tax Act and Article 9 of the DTAA. The interest rate must be at arm's length, and any excess amount may be denied treaty benefits under Article 11(7).

Practical Examples and Calculations

Example 1: Saudi Bank Lending to an Indian Company

A Saudi commercial bank provides a USD 10 million loan to an Indian infrastructure company at 5.5% annual interest. Annual interest payment = USD 550,000 (approximately INR 4,58,00,000).

• Without DTAA: Tax at domestic rate ≈ 22.88% = INR 1,04,79,040
• With DTAA: Tax at treaty rate = 10% = INR 45,80,000
• Net saving: INR 58,99,040 (approximately USD 70,800) per year

Example 2: NRI in Saudi Arabia with Indian NRO Deposits

An NRI working in Riyadh has NRO fixed deposits of INR 25,00,000 earning 7% interest = INR 1,75,000 annually.

• Without DTAA: Tax at domestic rate for individual (highest slab) ≈ 31.2% = INR 54,600
• With DTAA: Tax at treaty rate = 10% = INR 17,500
• Net saving: INR 37,100

Note: If the NRI has NRE or FCNR deposits, the interest is exempt under Section 10(4)(ii) (NRE) or Section 10(15)(iv)(fa) (FCNR) regardless of the DTAA.

Example 3: Sukuk Financing from Saudi Arabia to India

A Saudi financial institution provides Sharia-compliant Sukuk financing of USD 50 million to an Indian company. The annual return (profit rate) = 6% = USD 3,000,000.

• Without DTAA: If classified as interest, domestic rate ≈ 22.88% = USD 686,400
• With DTAA: If classified under Article 11, treaty rate = 10% = USD 300,000
• Net saving: USD 386,400 per year

The classification of Sukuk returns under the DTAA depends on the specific structure and whether Indian authorities accept it as income from debt-claims under Article 11.

Frequently Asked Questions

What is the interest withholding tax rate under the India-Saudi Arabia DTAA?

Under Article 11(2) of the India-Saudi Arabia DTAA, the maximum withholding tax rate on income from debt-claims (interest) is 10% of the gross amount, provided the recipient is the beneficial owner and a tax resident of Saudi Arabia. India's domestic rate is 20% plus surcharge and cess.

Why does the India-Saudi Arabia DTAA use the term "income from debt-claims" instead of "interest"?

The treaty uses "income from debt-claims" to accommodate Islamic finance principles prevalent in Saudi Arabia, where conventional interest (riba) carries specific religious significance. In practice, this term covers both conventional interest and returns from Sharia-compliant financing instruments.

Can an NRI in Saudi Arabia use the DTAA to reduce tax on Indian bank deposit interest?

Yes, for NRO deposits. NRIs in Saudi Arabia can claim the 10% DTAA rate on NRO deposit interest instead of the higher domestic rate. However, interest on NRE and FCNR deposits is already exempt under Sections 10(4)(ii) and 10(15)(iv)(fa) respectively of the Income Tax Act, making the DTAA provisions unnecessary for those deposit types.

Does the 10% rate apply to Sharia-compliant financing returns?

Returns from Sharia-compliant instruments such as Murabaha, Ijara, and Sukuk may qualify under Article 11 if the economic substance constitutes income from debt-claims. However, the classification depends on the specific structure and may be subject to examination by Indian tax authorities.

What is the impact of the MLI on interest taxation under this DTAA?

Both India and Saudi Arabia have ratified the MLI. The Principal Purpose Test (PPT) now applies, allowing Indian tax authorities to deny the 10% rate if obtaining treaty benefits was one of the principal purposes of a financing arrangement. The MLI entered into force for Saudi Arabia on 1 May 2020.

What documents must a Saudi lender provide to claim the 10% rate?

A Saudi lender must provide a valid Tax Residency Certificate from ZATCA, Form 10F (filed electronically), a beneficial ownership declaration, and a no-PE declaration. The Indian payer must file Form 15CA and obtain Form 15CB before remitting the interest payment.

How do transfer pricing rules apply to interest between Indian and Saudi related parties?

Interest on loans between associated enterprises must be at arm's length under India's transfer pricing rules (Chapter X) and Article 9 of the DTAA. The interest rate, loan amount, and terms must match what unrelated parties would agree upon. Any excess interest beyond arm's length may be denied the treaty benefit under Article 11(7).