Interest Tax Rate Between India and South Korea Under DTAA

Interest Tax Rate Between India and South Korea

The India-South Korea Double Taxation Avoidance Agreement (DTAA) was comprehensively revised and re-signed on 18 May 2015, replacing the earlier 1985 treaty. The revised agreement entered into force on 12 September 2016 and applies in India from FY 2017-18 onwards. Under Article 11 of the revised treaty, interest arising in one Contracting State and paid to a beneficial owner resident in the other Contracting State is subject to a maximum withholding tax rate of 10% of the gross amount.

This represents a significant reduction from the old treaty's interest rate of 15%. The revised rate of 10% was introduced specifically to promote cross-border investment flows and technology transfer between India and South Korea. Additionally, the treaty provides a complete exemption for interest paid to or guaranteed by government entities and central banks under Article 11(3).

Compared to India's domestic withholding rate of 20% (plus surcharge and health & education cess, yielding approximately 20.8%), the 10% treaty rate delivers savings exceeding 10% on every interest payment — making the revised India-South Korea DTAA one of the more favourable interest tax treaties for Korean lenders operating in India.

Treaty Rate vs Domestic Rate: Detailed Comparison

The reduction in interest withholding rates under the revised treaty is one of its most significant improvements. Here is a comprehensive comparison:

Under Section 115A of the Income Tax Act, 1961, interest paid to non-residents on foreign currency loans is taxed at 20%. With surcharge (2-5%) and 4% cess, the effective rate reaches approximately 20.8% to 21.84%. The revised DTAA rate of 10% applies without surcharge or cess, delivering savings exceeding 10.8% on general interest payments.

On South Korea's side, domestic withholding tax on interest paid to non-residents is 20% (plus 2% local income tax, totalling 22%). The 10% DTAA rate therefore provides a significant benefit for Indian lenders receiving interest from Korean borrowers as well.

For companies structuring cross-border financing, see our FDI advisory and FEMA-RBI compliance services.

Who Qualifies for the Reduced Rate

Accessing the 10% treaty rate requires meeting specific conditions:

Beneficial Ownership Requirement

Article 11(2) limits the reduced rate to interest where the beneficial owner is a resident of the other Contracting State. The beneficial owner must have genuine economic ownership — the right to use and enjoy the interest income without obligation to pass it through to another person. Back-to-back lending arrangements designed solely to access treaty rates will be scrutinised and potentially denied.

Government Exemption — Article 11(3)

A complete exemption from source-country tax applies to interest paid to or guaranteed by:

• The Government of the other Contracting State or a political subdivision thereof
• The central bank of the other Contracting State (Reserve Bank of India or Bank of Korea)
• Government-owned or government-specified financial institutions, including development banks and export credit agencies
• Loans guaranteed or insured by the government or its instrumentalities

This exemption is particularly relevant for Korean government-backed lending for infrastructure projects in India and Indian sovereign lending to Korean institutions.

No PE Connection

The debt-claim generating the interest must not be effectively connected with a permanent establishment (PE) of the beneficial owner in the source state. If such a connection exists, the interest is taxed as business profits under Article 7 at regular corporate rates rather than the 10% rate under Article 11.

Anti-Abuse Provisions

The revised treaty incorporates anti-abuse measures aligned with OECD BEPS standards. India's domestic GAAR provisions (effective from 1 April 2017) can independently deny treaty benefits for arrangements lacking commercial substance. The MLI, signed by both countries, adds additional anti-abuse filters through the Principal Purpose Test (PPT).

Interest-Specific Treaty Provisions Under Article 11

Article 11 of the revised India-South Korea DTAA contains detailed provisions governing interest taxation:

Article 11(1): Primary Taxing Right

Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in the recipient's state of residence. This establishes the residence state's primary right to tax interest income.

Article 11(2): Source State Rate Cap

The source state may also tax interest, but the tax shall not exceed 10% of the gross amount of the interest if the beneficial owner is a resident of the other Contracting State. This is a reduction from the 15% rate under the old 1985 treaty and reflects the two countries' commitment to facilitating cross-border capital flows.

Article 11(3): Government and Institutional Exemption

Interest paid to or guaranteed by the government, central banks, and government-owned financial institutions is fully exempt from tax in the source state. The exemption covers both direct lending by these entities and third-party loans guaranteed by them.

Article 11(4): Definition of Interest

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. It includes income from government securities, bonds, and debentures, as well as premiums and prizes attaching to such instruments. Notably, the revised treaty specifies that penalty charges for late payment shall not be considered as interest — this is a new clarification not present in the old treaty.

Article 11(5): PE Exception

If the beneficial owner has a PE in the source state and the debt-claim is effectively connected with that PE, Article 11 does not apply. Instead, the interest is taxed as business profits under Article 7, subject to net-basis taxation at applicable corporate rates.

Article 11(6): Source Rule

Interest is deemed to arise in a Contracting State when the payer is a resident of that state, or when the debt was incurred in connection with a PE in that state. This prevents disputes over interest sourcing in complex multi-jurisdictional arrangements.

Documentation Required for Claiming the Reduced Rate

Indian entities paying interest to South Korean residents must maintain proper documentation:

Tax Residency Certificate (TRC)

The South Korean lender must provide a valid Tax Residency Certificate (TRC) from the National Tax Service of South Korea confirming tax residency for the relevant financial year. For entities claiming the government exemption under Article 11(3), additional documentation evidencing government ownership or guarantee is required.

Form 10F

Under Section 90(5) of the Income Tax Act read with Rule 21AB, the non-resident must furnish Form 10F to the Indian borrower. Form 10F provides supplementary information not contained in the TRC, including PAN (if available), status, and residential period.

Self-Declaration and No-PE Certificate

A self-declaration confirming that the Korean lender is the beneficial owner of the interest, the debt-claim is not PE-connected, and the lending arrangement is not primarily designed to access treaty benefits.

Loan Documentation

The loan agreement, board resolutions, and evidence of RBI/FEMA approvals for External Commercial Borrowings (ECBs) must be available for the Indian payer's CA when preparing Form 15CB.

Withholding Procedure for Indian Payers

The withholding compliance process for interest payments to South Korean residents under Section 195 of the Income Tax Act:

Step 1: Verify Treaty Eligibility

Confirm the Korean lender's tax residency through the TRC, verify beneficial ownership, and determine whether the government exemption under Article 11(3) applies. Check for PE connections that would redirect taxation to Article 7.

Step 2: Deduct TDS at Applicable Rate

Deduct TDS at 10% for general interest payments, or 0% for payments qualifying under the government exemption. No surcharge or cess applies to treaty rates. If documentation is incomplete, apply the full domestic rate of 20% plus surcharge and cess.

Step 3: File Form 15CA/15CB

For remittances exceeding INR 5 lakh, file Form 15CA online after uploading the CA's certificate in Form 15CB. The CA must certify the DTAA article applied, rate of TDS, and treaty eligibility. For ECBs, concurrent RBI reporting under FEMA regulations may be required.

Step 4: Deposit TDS and File Returns

Deposit TDS within prescribed deadlines and file quarterly TDS returns in Form 27Q. Maintain all documentation for a minimum of six years. For end-to-end compliance support, consult our tax advisory and transfer pricing services.

Common Disputes and Judicial Precedents

Key areas of dispute in the application of interest provisions under the India-South Korea DTAA:

Transition Rate Application

The revised treaty reduced interest rates from 15% to 10%, effective from FY 2017-18. Disputes have arisen regarding interest payments straddling the transition date — whether interest accrued before but paid after 1 April 2017 should be taxed at 15% or 10%. The prevailing view is that the date of credit or payment determines the applicable rate.

Penalty Interest and Late Payment Charges

The revised treaty explicitly excludes penalty charges for late payment from the definition of interest under Article 11(4). However, disputes have arisen regarding whether compensatory interest, default interest, and penal interest all fall within this exclusion. The specific characterisation of the charge under the loan agreement is critical.

ECB Interest Rate and Transfer Pricing

Interest rates on inter-company loans between Indian and Korean group entities are subject to transfer pricing scrutiny under Section 92 of the Income Tax Act. The Indian Transfer Pricing Officer may compare the interest rate with arm's length benchmarks (LIBOR/SOFR spread, comparable uncontrolled price method) and make adjustments that increase the taxable interest amount.

Korean Banks with Indian Branches

Several major Korean banks (Shinhan, KEB Hana, Woori) maintain branch offices in India. When loans are booked at the Korean head office but serviced or negotiated through the Indian branch, disputes arise regarding PE attribution. If the branch constitutes a PE and the loan is effectively connected to it, interest is taxed as business profits at 35% rather than the 10% treaty rate.

Mutual Agreement Procedure (MAP) and APA

The revised treaty introduced Article 9(2), enabling taxpayers to apply for MAP in transfer pricing disputes and bilateral Advance Pricing Agreements (APAs). This is significant for Korean companies with substantial interest payment flows to India, as it provides a mechanism to resolve double taxation without unilateral domestic litigation.

Practical Examples and Calculations

Example 1: Korean Bank Lending to Indian Company

A South Korean commercial bank lends USD 20 million to an Indian infrastructure company at 5.5% interest per annum. Annual interest payment: USD 1,100,000 (approximately INR 9,24,00,000 at INR 84/USD).

• Without DTAA: TDS at 20% + surcharge (2%) + cess (4%) = ~20.8% = INR 1,92,19,200 withheld
• With DTAA (Article 11(2)): TDS at 10% = INR 92,40,000 withheld
• Tax saving: INR 99,79,200 per year

Example 2: Government-Backed Korean Development Loan

Korea Development Bank (government-owned) extends a USD 30 million development loan to an Indian PSU. Annual interest at 4%: USD 1,200,000 (approximately INR 10,08,00,000).

• Without DTAA: TDS at ~20.8% = INR 2,09,66,400 withheld
• With DTAA (Article 11(3)): TDS at 0% = NIL withheld
• Tax saving: INR 2,09,66,400 per year — complete exemption

Example 3: Inter-Company Loan (Transfer Pricing Consideration)

A Korean parent company lends INR 50 crore to its Indian subsidiary at 8% interest. The Indian Transfer Pricing Officer benchmarks comparable ECB rates at 6%. The adjustment increases taxable interest from INR 4 crore to INR 4 crore (no adjustment if rate is at arm's length) or adjusts downward if the rate exceeds arm's length. The 10% DTAA rate applies to the final determined interest amount. Companies should conduct a transfer pricing study upfront to mitigate adjustment risk.

Frequently Asked Questions

What is the DTAA tax rate on interest between India and South Korea?

Under Article 11(2) of the revised India-South Korea DTAA (effective from FY 2017-18), the maximum withholding tax rate on interest is 10% of the gross amount when the beneficial owner is a resident of the other Contracting State. This was reduced from 15% under the old 1985 treaty. Interest paid to government entities is fully exempt under Article 11(3).

When did the reduced 10% interest rate come into effect?

The revised India-South Korea DTAA was signed on 18 May 2015 and entered into force on 12 September 2016. In India, it applies to income derived in fiscal years beginning on or after 1 April 2017 (FY 2017-18). Interest payments from FY 2017-18 onwards benefit from the reduced 10% rate.

Are penalty interest payments covered by the treaty rate?

No. The revised treaty explicitly states that penalty charges for late payment are not considered as interest under Article 11(4). Therefore, penalty interest does not qualify for the 10% treaty rate and may be taxed at the full domestic rate or under other treaty articles, depending on its characterisation.

Does the 10% rate apply to interest on ECBs from South Korea?

Yes, provided the Korean lender is the beneficial owner and a tax resident of South Korea, and the ECB complies with RBI guidelines under FEMA. The Indian borrower must withhold TDS at 10% and complete both income tax compliance (Form 15CA/15CB, Form 27Q) and FEMA compliance (ECB reporting to RBI).

What if a Korean bank has a branch in India?

If the Korean bank has a PE in India (such as a branch office) and the loan is effectively connected with that PE, the interest is taxed as business profits under Article 7 at up to 35% on a net basis, not the 10% gross rate under Article 11. The PE attribution question is fact-specific and often disputed.

How does the MAP provision help resolve disputes?

The revised treaty's Article 9(2) allows taxpayers to apply for Mutual Agreement Procedure (MAP) in transfer pricing disputes and bilateral Advance Pricing Agreements (APAs). This enables India and South Korea to resolve double taxation issues through inter-governmental consultation rather than unilateral domestic proceedings.