Leveraging ECB for MSMEs: Tax Implications and Advisory Tips

For Indian MSMEs looking at external growth capital, External Commercial Borrowings (ECBs) offer an increasingly viable route. However, the borrowing mechanics must align with tax, regulatory and compliance frameworks to ensure the benefit actually materialises. Here’s a grounded look at the key tax implications, verified statistics and advisory steps.

Why this matters now

• In March 2025, Indian companies filed ECB intents totalling US$ 11.04 billion, a 72-month high, according to Reserve Bank of India (RBI) data.
• Over the same period, net ECB inflows were about US$ 4.4 billion for April-May 2025, rising 158% versus the prior year.
• India’s external debt reached US$ 736.3 billion as of end-March 2025, up 10% year-on-year, highlighting the broader external borrowing context.

For MSMEs, these figures indicate stronger foreign financing interest, but also a heightened environment for external borrowing risk, compliance scrutiny, and currency exposure.

Tax & regulatory compliance touch-points every MSME should master

• Withholding tax (TDS) on interest payable to non-resident lenders: Borrowers must assess whether the rate is as per domestic law or reduced via tax treaty, and ensure documentation (Residency Certificate, beneficial ownership) is in place.

• Interest deductibility: Interest on foreign loans is generally deductible, yet conditions such as business purpose, arm’s-length terms and thin-capitalisation may restrict the deduction.

• Foreign exchange gain/loss treatment: Since ECBs involve foreign-currency debt, accounting for FX differences and hedges is crucial, especially given the external debt exposure noted above.

• FEMA/ECB framework classification: MSMEs must confirm they meet the eligibility criteria under the RBI’s ECB FAQs.

• Stamp duty and collateral registration: If securities are pledged or a mortgage executed, state-level stamp duty may apply and affect the net cost of borrowing.

Quick comparison: ECB vs domestic bank debt for MSMEs

Practical advisory steps for MSMEs

1. Confirm eligibility: Check RBI’s ECB FAQs, ensure the firm falls under permissible sectors, and review borrowing routes (automatic vs approval).
2. Model tax cash flows: Include probable withholding, deductibility limits, hedging costs and currency risk when comparing financing options.
3. Match currency and flow: If revenues are primarily rupee-based, consider matching currency exposure or budgeting for hedging costs.
4. Document purpose and structure: Clearly articulate business purpose, loan tenor, security and repayment plan; this strengthens deduction claims.
5. Engage early with advisers: Especially if tax treaties, transfer pricing or overseas lender structuring are involved.

For MSMEs, ECBs are increasingly more than just a large corporate territory. With verified data pointing to renewed foreign borrowing activity and deeper access to global capital, the opportunity is real. But it must be pursued with discipline: tax-efficient structuring, compliance clarity and currency-risk management are the fundamental enablers.

If you’re planning India market entry or expansion and want support with ECB strategy, tax review or advisory fit-for-purpose, fill out the form, and our India market-entry team is ready to collaborate.