The Centre is likely to do away with the withholding tax of 20 per cent on foreign loans to encourage companies to access the external market for debt.

The government introduced the tax in 2001-02 on the interest payable by domestic companies on external commercial borrowing repayments.

The Centre took the plea that such a tax was necessary to ensure there was no misuse of the loan provisions by companies.

The revenue department was of the opinion that the withholding tax would reduce the arbitrage opportunities offered by a depreciating rupee.

Flush with forex reserves of over $72 billion, the Centre is now considering reinstating the exemptions provided under Sections 10(15)(iv)c and f of the Income Tax Act.

Under these sections, the finance ministry earlier provided that any interest payable by a company on forex loans would be fully exempt from income tax.

The exemption was given as foreign lenders usually insisted that any withholding  liability would have to be borne by domestic borrowers.

With the progressive reduction in domestic interest rates and the removal of the tax incentive, India Inc's appetite to raise loans such loans has shrunk.

But with the liberalisation of the approval norms for raising ECBs, the demand for the tax exemption has been revived.

While withdrawing the tax concession in the Budget for 2001-02, the finance ministry had argued that such exemptions did not benefit anybody but only reduced the tax revenue.

It said since the lenders' interests were covered as they got tax credit for any tax paid in India, the clause was infructuous.

But it did not address the issue of the withholding tax raising the cost of borrowing.

One result of the imposition of the tax has been the progressive decline in the approval for external commercial borrowings by both public and private sector companies, even though the interest rates for such loans is at a historic low in the international market.

Currently, there is hardly any proposal to raise ECBs pending with the finance ministry.