Debt financing refers to the process by which a company raises funds by borrowing, typically through loans, or other credit instruments.

Under Section 15(2)(a) of the Income Tax Act (Cap. 470), interest on debt that is wholly and exclusively incurred in the production of income is deductible for tax purposes.

For non-resident loans whether from related parties or third parties, the Finance Act, 2021 adopted the OECD (Organization for Economic Cooperation and Development) guidelines and specifically Base Erosion on Profit Shifting (BEPS) Action 4 introducing a fixed ratio rule to replace the previous thin cap rules.

Allowable interest expense is capped at 30% of Earnings before Tax, Interest, Depreciation and Amortization (EBITDA). The immediate impact of the rule is significant tax liabilities for companies with a significant debt financing component because interest expense exceeding 30% of EBITDA will be disallowed.

 Important to note that any interest in excess of thirty per cent of EBITDA is an allowable deduction in ascertaining the total income of a person in the subsequent three years of income to the extent that the deduction of interest on loans from non-resident persons does not exceed the thirty percent threshold.