[Opinion] GIFT City Tax Holidays and Liquidity Drag in Cross-Border Debt

Ajeet Singh – [2026] 186 taxmann.com 951 (Article)

1. Abstract

GIFT City’s tax incentives have improved the appeal of International Banking Units for cross-border lending. Yet tax holidays do not remove the liquidity friction created when withholding tax is deducted at source while foreign tax credit recovery is delayed.

This article argues that the key issue is not the local tax rate in GIFT City, but the timing mismatch between cash leakage and credit realisation. Even when withholding tax is ultimately recoverable, the interim funding requirement creates a real economic drag. For thin-margin lending structures, that drag can compress or, in extreme cases, eliminate profit.

2. The Structural Mismatch

Cross-border debt is often assessed through a headline tax lens: if local tax is low or nil, the economics should improve automatically. That assumption is incomplete.

In practice, an IFSC branch booking cross-border debt may still face withholding tax in the borrower’s jurisdiction. Although that tax may later be creditable under applicable rules, it is deducted immediately from cash flows. The desk must then fund the shortfall internally until the credit is realised. This creates a negative carry effect that is separate from the accounting treatment.

Put simply, the tax may be recoverable in theory, but it remains a cash cost in practice.

[*It is vital to distinguish between domestic banking inflows and international asset allocations within the IFSC. While the Central Board of Direct Taxes (CBDT)—via Notification Nos. 65/2022, 28/2024, 3/2025, and 67/2025—has successfully neutralized domestic Tax Deducted at Source (TDS) friction for Indian entities remitting payments to IFSC units, these exemptions do not extend to foreign sovereign jurisdictions. When a GIFT City International Banking Unit (IBU) extends debt facilities to a non-resident foreign borrower, the borrower’s local tax authority applies its own withholding mandates under Article 11 of the prevailing Double Taxation Avoidance Agreements (DTAA). Consequently, the core liquidity friction modeled herein—driven by foreign cash leakage and the prolonged timing lag of Rule 128 Foreign Tax Credit (FTC) realisation—remains an active operational drag for outbound cross-border loan portfolios]

3. Why Cash Flow Matters

The distinction between accounting recoverability and treasury reality is critical.

From an accounting perspective, foreign withholding tax may be treated as recoverable through foreign tax credit. From a treasury perspective, however, the cash is gone on day one, while recovery may occur much later due to filing cycles, documentation requirements, and tax processing timelines.

That timing gap creates a liquidity cost. In other words, the transaction should not be judged only on gross spread. It must be evaluated on net spread after liquidity drag.

4. Assumptions and Method

For illustration, this analysis assumes:

• Principal –  USD 100 million
• Gross Withholding Tax – 10% at source
• Internal Cost of Funds – 5.00%
• Foreign Tax Credit Recovery Lag – 12 to 18 months
• Funding Basis – simple, non-compounded for baseline illustration
• Day-count Convention – Annualised for simplicity

These assumptions are intended to show the mechanism. Actual outcomes will vary by jurisdiction, treaty rate, recovery timing, and treasury funding basis.

Methodology Note –  The purpose of the model is to isolate the funding cost of trapped withholding tax during the credit recovery period. It does not attempt to capture all balance-sheet, legal, or transfer pricing effects.

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