CBDT Explains NBFC Eligibility For Income Tax Deductions Based on Actual Payments

The Central Board of Direct Taxes (CBDT) has issued a notification specifying certain categories of Non-Banking Financial Companies (NBFCs) eligible for income tax deductions to be applicable only upon actual payment. 

This notification is particularly important in relation to interest payments made to NBFCs. As a result of amendments introduced in the Finance Act of 2023, the new classification will be effective starting from September 22. 

The notification explains, 'In exercise of the powers conferred by clause (da) of section 43B of the Income-tax Act, 1961, the Central Government, hereby, notifies the following classes of NBFCs, for the purpose of the said clause, namely, all NBFCs classified in the top layer, in the upper layer, and in the middle layer.

Additionally, it explains, 'A deposit-taking non-banking financial company or systemically important non-deposit-taking non-banking financial company,' the phrase 'such class of non-banking financial companies as may be notified by the Central Government in the Official Gazette in this regard' will be replaced.'"

This change has been implemented through the latest notification.

Income Tax Act, Section 43 Explained: Section 43 of the Income Tax Act deals with how deductions are allowed based on actual payments made. In particular, it includes clause (da), which relates to the interest payments on loans or borrowings from certain categories of Non-Banking Financial Companies (NBFCs). These payments must adhere to the terms and conditions specified in the loan agreement. 

Under this section, taxpayers, including NBFCs, are only permitted to claim deductions for expenses when the actual payment is made, not when the expense accrues.

The notification also references the definitions of "middle layer," "upper layer," and "top layer" as outlined by the Reserve Bank of India (RBI). According to the RBI's guidelines, the middle layer includes all deposit-taking NBFCs (NBFC-Ds), regardless of their asset size. It also includes non-deposit-taking NBFCs with assets totaling Ôé╣1,000 crore or more. Additionally, it covers NBFCs engaged in activities such as standalone primary dealers (SPDs), infrastructure debt funds (IDF-NBFCs), core investment companies (CICs), housing finance companies (HFCs), and infrastructure finance companies (NBFC-IFCs).

Similarly, the upper layer consists of NBFCs that have been specifically identified by the Reserve Bank for enhanced regulatory requirements, based on predefined parameters and scoring criteria. Among these, the top ten NBFCs with the highest asset sizes will always belong to the upper layer, regardless of other factors.

This notification clarifies the application of these rules and changes related to deductions and actual payments. The RBI circular explains that the top layer should ideally remain vacant. However, it can be filled if the RBI determines that certain NBFCs in the upper layer pose a significant increase in systemic risk. In such cases, these NBFCs will be moved from the upper layer to the top layer, as clarified.

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