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, Article 11(3) exempts interest that is derived and beneficially owned by the two Governments and by a closed list of named public institutions.

Compared to India's domestic withholding rate of 20% (plus surcharge and health & education cess, yielding approximately 21.216%), the 10% treaty rate delivers savings exceeding 11 percentage points 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 207(1) (Table, Sl. Nos. 1–3) of the Income-tax Act, 2025 (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 21.216% to 21.84%. The revised DTAA rate of 10% applies without surcharge or cess, delivering savings exceeding 11 percentage points 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 where the interest is derived and beneficially owned by:

• The Government of the other Contracting State, or a political sub-division or local authority thereof
• In the case of India: the Reserve Bank of India, the Export-Import Bank of India, or the National Housing Bank
• In the case of Korea: the Bank of Korea, the Export-Import Bank of Korea, the Korea Development Bank, the Korea Trade Insurance Corporation, or the Korea Finance Corporation
• Any other institution agreed from time to time between the competent authorities of the two States

The test is entirely recipient-side. Article 11(3) contains no exemption for loans merely guaranteed or insured by a government — a commercial Korean lender does not become exempt because a Korean public agency guarantees the facility. The exemption matters chiefly for direct lending by the listed Korean policy institutions into Indian infrastructure, and for Indian sovereign and Reserve Bank lending to Korean counterparties.

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 arising in a Contracting State is fully exempt from tax in that State if it is derived and beneficially owned by the other State's Government, a political sub-division or local authority, or by one of the institutions named in Article 11(3)(b) — the Reserve Bank of India, Export-Import Bank of India and National Housing Bank on the Indian side; the Bank of Korea, Export-Import Bank of Korea, Korea Development Bank, Korea Trade Insurance Corporation and Korea Finance Corporation on the Korean side — or by any other institution the competent authorities later agree. There is no guarantee-based limb: a loan guaranteed by one of these bodies but held by a commercial lender stays within the 10% cap of Article 11(2).

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. Article 11(4) also specifies that penalty charges for late payment shall not be regarded as interest for the purposes of the Article.

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 exemption under Article 11(3), additional documentation establishing that the claimant is itself the Government, a political sub-division or local authority, or one of the institutions named in that Article, is required.

Form 41 (formerly Form 10F)

Under section 159 of the Income-tax Act, 2025 (section 90(5) of the Income-tax Act, 1961), the non-resident must furnish Form 41 to the Indian borrower. Form 41 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 146 (formerly Form 15CB).

Withholding Procedure for Indian Payers

The withholding compliance process for interest payments to South Korean residents under section 393(2) of the Income-tax Act, 2025 (Table, Sl. No. 17; section 195 of the Income-tax Act, 1961):

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

For remittances exceeding INR 5 lakh, file Form 145 online after uploading the CA's certificate in Form 146. 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 144 (formerly 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 161 of the Income-tax Act, 2025 (section 92 of the Income-tax Act, 1961). 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 Corresponding Adjustments

Two distinct provisions do the work here. Article 9(2) obliges the other State to make an appropriate corresponding adjustment where one State has adjusted the profits of an associated enterprise on transfer pricing grounds. Article 25 is the Mutual Agreement Procedure article — the route by which a taxpayer presents its case to the competent authority of its own State so that the two authorities can resolve the resulting double taxation, and the treaty basis on which a bilateral Advance Pricing Agreement (APA) with Korea is concluded. This matters for Korean groups with substantial interest flows to India, because it opens a government-to-government route out of double taxation rather than leaving domestic litigation as the only option.

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%) = ~21.216% = INR 1,96,03,584 withheld
• With DTAA (Article 11(2)): TDS at 10% = INR 92,40,000 withheld
• Tax saving: INR 1,03,63,584 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% + surcharge (5%, income above INR 10 crore) + cess (4%) = ~21.84% = INR 2,20,14,720 withheld
• With DTAA (Article 11(3)): TDS at 0% = NIL withheld
• Tax saving: INR 2,20,14,720 per year — complete exemption, because the Korea Development Bank is one of the institutions named in Article 11(3)(b)(ii)

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

A Korean parent company lends INR 50 crore to its Indian subsidiary at 8% interest — INR 4 crore of interest a year. The Indian Transfer Pricing Officer benchmarks comparable borrowings at 6%, or INR 3 crore, and disallows the INR 1 crore excess as a deduction in the Indian subsidiary's hands. The 10% DTAA rate under Article 11(2) continues to apply to the interest actually paid and withheld on; the disallowance bites on the subsidiary's own taxable profit, not on the withholding. 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 derived and beneficially owned by the two Governments, or by an institution named in Article 11(3) such as the Export-Import Bank of Korea or the Korea Development Bank, is fully exempt in the source State.

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 145/Forms 146 and 144) 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?

Article 9(2) requires the other State to make an appropriate corresponding adjustment when one State makes a transfer pricing adjustment to an associated enterprise's profits. Article 25 — the Mutual Agreement Procedure article — is the route by which a taxpayer takes the resulting double taxation to the competent authority of its own State for resolution with the other State, and it is also the treaty basis for a bilateral Advance Pricing Agreement (APA). Together they let India and South Korea settle the issue through inter-governmental consultation rather than unilateral domestic proceedings.