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KCM Consultants LLC
Corporate Tax

Funding a UAE Subsidiary From India: Equity vs Debt

An Indian parent that lends to its UAE subsidiary buys a 9% deduction with a 25% tax bill; funding with equity usually leaves less tax in the group.

By Suril Mehta, CA, Partner, K C Mehta & Co LLP | KCM Consultants LLC, Dubai

Published 11 November 202610 min

Key Takeaways

  • A loan from India to a UAE subsidiary at 10% creates interest income taxed in India at about 25% as it accrues, against a UAE deduction worth only 9% (or nothing for a 0% free zone company).
  • On the standard 20 equity / 80 loan split, the annual group leakage is 1.28 million. This article reconciles that figure line by line.
  • An interest-free loan is not an option: FEMA requires an arm’s length rate, and transfer pricing will impute one on both sides.
  • Equity is taxed in India only when a dividend is declared, and the Income-tax Act 2025 allows a deduction for dividends the Indian company passes on in time.
  • Keep debt for money you expect back within a year or two. For a longer-dated exit route, use a buyback or redeemable preference shares, after checking their accounting and FEMA classification.

Why this matters

Many Indian groups set up a UAE subsidiary with a thin slice of equity and a large shareholder loan. It looks tidy and it is the usual default. KCM’s position is that it is, in most cases, the most expensive of the available choices. The reason is a rate mismatch: the deduction arises in a 9% jurisdiction and the income arises in a 25% jurisdiction.

All figures below are in one currency unit, in millions, for illustration. The principles do not depend on the currency, but the UAE interest cap is stated in AED and is tested separately in section 3.

1. The loan: where the 1.28 million comes from

An Indian company puts 100 into a UAE subsidiary: 20 as equity and 80 as a loan at 10%.

Line Working Amount (m)
Annual interest on the loan 80 x 10% 8.00
UAE corporate tax saved on the deduction 8.00 x 9% 0.72
Indian tax on the same interest 8.00 x 25% 2.00
Net annual cost to the group 2.00 – 0.72 1.28

The arithmetic reconciles. Two refinements matter.

  • The 25% is a rounded rate. A company that has opted into the 22% regime under section 200 of the Income-tax Act 2025 (section 115BAA of the 1961 Act) pays 22% plus a flat 10% surcharge and 4% cess, which is 25.168%. On that rate the Indian tax is 8.00 x 25.168% = 2.013 and the net cost is 2.013 – 0.72 = 1.293, about 1.29. A company on the turnover-based 25% rate pays surcharge on top once income passes INR 1 crore, so its effective rate is higher still.
  • The 0.72 is the best case. It exists only if the UAE subsidiary is a taxable mainland company with at least 8.00 of profit to absorb the deduction. A free zone company taxed at 0%, or one still in losses, gets nothing, and the leakage is the full 2.00.

India taxes interest as it accrues, not when it is received, so the Indian company pays the 2.00 even if the subsidiary has not yet paid the interest.

2. Debt vs equity vs preference shares, side by side

Assumptions: the UAE subsidiary earns 20 a year before financing costs, is taxed at 9% (the AED 375,000 zero-rate band is ignored), and the interest is within the UAE cap. The preference share cases assume a 10% dividend on 80 of redeemable preference shares (RPS), with no UAE deduction. Group tax is UAE tax plus Indian tax for the year.

A. 20 equity + 80 loan B. 100 equity C1. 20 equity + 80 RPS, dividend passed on C2. 20 equity + 80 RPS, dividend not passed on
UAE profit before financing 20.00 20.00 20.00 20.00
Deductible financing cost 8.00 0.00 0.00 0.00
UAE taxable income 12.00 20.00 20.00 20.00
UAE tax at 9% 1.08 1.80 1.80 1.80
Cash paid up to India 8.00 (interest) 0.00 (no dividend declared) 8.00 (dividend) 8.00 (dividend)
Indian tax on that receipt 2.00 0.00 0.00 2.00
Group tax 3.08 1.80 1.80 3.80
Group cash after tax 16.92 18.20 18.20 16.20
Check: 20.00 less group tax 16.92 18.20 18.20 16.20

How to read it:

  • B against A: 3.08 – 1.80 = 1.28. This is the same 1.28 as in section 1, so the two tables agree.
  • C1: the preference dividend is not deductible in the UAE, but it is not taxed in India either if the Indian company distributes it onward in time. Group tax equals the all-equity case.
  • C2: if the Indian company keeps the dividend, India taxes it at 25% and the group is worse off than under a plain loan by 0.72, the lost UAE deduction. Preference shares are not automatically better than debt; the onward distribution is what makes them work.
  • Free zone case: at 0% UAE tax, debt costs nothing in the UAE and 2.00 in India, so group tax is 2.00 against nil for equity with no dividend declared.

3. The rules that drive the numbers

UAE interest cap. Under Article 30 of Federal Decree-Law No. 47 of 2022, deductible net interest expenditure is limited to 30% of EBITDA. Ministerial Decision No. 126 of 2023 provides that the limit does not apply where net interest expenditure for the period is AED 12 million or less, and that above that level the taxpayer may deduct the higher of AED 12 million and the 30% figure. If the example is in AED, interest of 8 is under the de minimis and the cap is not engaged. At larger scale it is: interest of 15 on EBITDA of 40 gives a limit of the higher of 12 and 30% x 40 = 12, so 3 is disallowed that year.

Related party loans. Article 31 denies the interest deduction on a loan from a related party where the loan relates to a dividend or profit distribution to a related party, a redemption or return of share capital, a capital contribution to a related party, or the acquisition of an interest in a person who becomes a related party. The deduction survives if the taxpayer shows the main purpose was not a Corporate Tax advantage, and under Article 31(3) no advantage is treated as arising where the related party lender pays tax on the interest at 9% or more. An Indian lender taxed at about 25% meets that test. An ordinary operating loan is not caught, but a subsidiary that on-lends to buy another group company, or to fund a distribution, needs checking.

FEMA. Under the Foreign Exchange Management (Overseas Investment) Regulations, 2022 (FEMA 400/2022-RB), an Indian entity may lend to a foreign entity only if the loan is backed by a loan agreement and the interest is charged on an arm’s length basis. The lending must sit within the financial commitment limit and the lender must have made overseas direct investment in, and have control of, the borrower. “Arm’s length” means a transaction between related parties conducted as if they were unrelated. A zero-interest ODI loan is therefore not available. Dues from the foreign entity must also be realised and repatriated within 90 days of falling due.

Transfer pricing. The rate is a transfer pricing item in both countries. A rate that India accepts and the UAE reduces produces an addition in one country with no matching relief in the other. For a Qualifying Free Zone Person, compliance with the UAE transfer pricing rules is a condition of the 0% rate, and a failure costs the status for the year and the following four tax periods. See our guide on UAE free zone 0% tax.

India: dividends and the deduction. A domestic company’s dividend income is taxed when declared. Section 148 of the Income-tax Act 2025 (section 80M of the 1961 Act) gives a deduction for dividend income, including dividends from a foreign company, up to the dividend the company itself distributes at least one month before the due date for filing its return. Section 200 expressly leaves the section 148 deduction available to a company on the 22% regime. Debt gives the Indian company neither the timing control nor this deduction.

UAE side of dividends. The UAE does not withhold tax on dividends or interest paid to non-residents (Article 45 sets a 0% rate), so the cost here is driven by Indian tax, not by treaty rate caps. If the UAE entity is a holding company receiving dividends from further subsidiaries, the participation exemption in Article 23 applies where it holds at least 5% (or an acquisition cost of AED 4 million or more) for at least 12 months and the participation is subject to tax at 9% or more. Dividends from UAE resident companies are exempt under Article 22.

4. When debt is still right

The one good argument for debt is that getting money back is easy. That is true, but in practice repayment rarely happens. Where an exit route is genuinely wanted, a buyback at the subsidiary level does the same job. Redeemable preference shares behave like debt on the way out while the annual return stays a dividend in India rather than interest.

Two checks come first. One is the UAE accounting classification of the shares: a liability-classified instrument may be reported as a financing cost, which affects the UAE result and the Article 30 computation. The other is FEMA classification, because “equity capital” under the Overseas Investment Rules covers equity shares, perpetual or irredeemable instruments and fully and compulsorily convertible instruments. Use debt for working capital or bridge funding you expect back in a year or two, priced at arm’s length and documented.

What to do / practical considerations

  1. Model the structure on the group’s own numbers: UAE profit, whether the entity is mainland or a free zone person, and the rate at which the Indian parent is actually taxed.
  2. Default to equity. Keep any loan short, documented and priced to a benchmark.
  3. Test the loan against Article 30 (AED 12 million de minimis, 30% of EBITDA) and, if it funds a distribution or an acquisition from a group company, Article 31.
  4. Plan the Indian side: whether to opt into section 200, and whether the parent will distribute in time for the section 148 deduction.
  5. Confirm treaty eligibility and the UAE tax residency certificate (see TRC rules); for the Indian tax on UAE income see our India income tax guide.
  6. Compare a branch against a company too: UAE company or branch.

This is a structuring point, not structuring advice. GAAR, treaty eligibility, stamp duty and the group’s own numbers all have to be considered.

FAQ

Can the Indian parent lend to the UAE subsidiary interest-free?
No. FEMA requires a loan to an overseas subsidiary to be backed by a loan agreement carrying arm’s length interest. Even if it were allowed, Indian and UAE transfer pricing would impute a rate.

Does India tax the interest if the subsidiary has not paid it?
Yes. India taxes interest as it accrues, so the Indian company can owe tax on interest it has not received.

Is there a limit on how much interest the UAE subsidiary can deduct?
Yes. Under Article 30, deductible net interest is capped at 30% of EBITDA, but the cap does not apply where net interest expenditure is AED 12 million or less. Above that, the higher of AED 12 million and the 30% figure is deductible.

Are redeemable preference shares better than a loan?
Only if the return is a dividend in India that the Indian company passes on in time, which then qualifies for the section 148 deduction. If it does not, the dividend is taxed at the company’s rate and the UAE deduction is also lost, as column C2 shows.

Does a UAE free zone company change the answer?
It strengthens the case for equity. A company taxed at 0% gets no benefit from an interest deduction, so the Indian tax on the interest is the whole leakage.

Talk to us

KCM advises Indian groups on funding, repatriation and tax structuring of UAE subsidiaries. Contact KCM to model your own numbers, or see our UAE corporate tax page. KCM’s Indian affiliate, K C Mehta & Co LLP, is at kcmehta.com.

Sources & last checked: 6 November 2026

This is not to be construed as legal advice. The actual advice will depend upon the facts and will have to take into consideration the case-specific facts and the anti-abuse regulations.

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