The Finance Act 2021 had inserted a new clause (4E) under section 10 of the Income-tax Act, 1961 ('IT Act') to exempt any income accrued or arisen to, or received by a non-resident if –
- Such income is a result of transfer of non-deliverable forward contracts; and
- Such contracts are entered into with an offshore banking unit of an International Financial Services Centre (IFSC).
The Finance Act 2021 also provided that the above exemption is subject to fulfilment of prescribed conditions.
In view of the above and to provide impetus to IFSC, the Central Board of Direct Taxes has now issued a notification1 to insert Rule 21AK (‘Rule’) to the Income-tax Rules, 1962, prescribing conditions for availing the exemption and to clarify a few expressions, especially the term “Non-Deliverable Forward Contracts”.
We, at BDO in India, have analysed and summarised the aforementioned Rule hereunder:
Conditions for availing the exemption
As per the Rule notified, the exemption under Section 10(4E) of the IT Act shall be subject to fulfilment of the following conditions:
- The Non-Deliverable Forward Contract should be entered into with an offshore banking unit which holds a valid certificate of registration granted under IFSC Authority (Banking) Regulations, 2020 by the IFSC Authority; and
- The contract should not be entered into by the non-resident through or on behalf of its permanent establishment in India.
The Rule also casts responsibility on the offshore banking unit to ensure adherence with condition no. 2 mentioned above.
Meaning of certain expressions
The Rule also clarifies the following expressions:
- Non-deliverable forward contract – This shall mean a contract for the difference between an exchange rate agreed before and the actual spot rate at maturity, with the spot rate being taken as the domestic rate or a market determined rate and such contract being settled with a single payment in a foreign currency.
- Permanent Establishment – The term ‘Permanent Establishment’ is assigned the meaning defined under Section 92F(iiia) of the IT Act. As per the said Section, permanent establishment includes a fixed place of business through which the business of an enterprise is wholly or partly carried on.
- Offshore banking unit – This shall mean a banking branch Unit located in the IFSC, as referred to in Section 80LA(1A) of the IT Act.
The IT Act had earlier introduced exemptions from tax liability upon transfer of certain capital assets, including derivatives, entered into by a non-resident on a recognised stock exchange located in IFSC. Vide Section 10(4E) of the IT Act, exemption has now also been given on transfer of non-deliverable forward contracts, which are also a type of derivative contract.
The above Rule prescribes twin conditions required to be fulfilled for claiming the exemption under section 10(4E) of the IT Act. The Rule has also cast a critical responsibility on the offshore banking unit, to ensure that the non-deliverable forward contract does not have connection with any non-resident’s permanent establishment in India.
Further, it would be pertinent to note that under section 80(LA) of the IT Act, a unit which has obtained permission under section 23(1)(a) of the Banking Regulation Act, 1949 or has obtained permission or registration under the Securities and Exchange Board of India Act, 1992 or any other relevant law in force, is allowed a profit linked deduction for 10 consecutive years, subject to fulfilment of certain conditions. However, for the purpose of exemption under section 10(4E) of the IT Act, the Rule restricts deduction to only a unit which holds a valid certificate of registration granted under IFSC Authority (Banking) Regulations, 2020 by the IFSC Authority.
1Notification Number 136/2021/F. No. 370142/53/2021-TPL (Part-II) dated 10 December 2021 notifying Income-tax (33rd Amendment) Rules, 2021