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Taxation of gain on FCCB

Jems (Proprietor) (40 Points)

10 October 2009

Plz help me,

What shall be tax treatment on gains/interest on FCCB of Tata Moters?

Thank in advance

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11 Replies

Rajeev (www.rkmco.com) (985 Points)
Replied 10 October 2009

The Authority for Advance Rulings (AAR) has ruled that the interest paid to a foreign company on convertible debentures is a part of the foreign company’s income and is liable to be taxed in India. Indian firms raise foreign currency denominated funds in the form of external commercial borrowings (ECBs) or foreign currency convertible bonds (FCCBs). While ECBs are pure loans, FCCBs have an in-built option for the lender to convert them into equity, though both in ECB and FCCB, the borrower is expected to make interest payments.

Also According to the AAR ruling, payment to the foreign company up to the date of conversion of bonds into equity is equivalent to interest paid on borrowed money, under Section 2(28A) of the Income Tax Act, 1961. This section defines “interest” as interest payable in any manner in respect of any money borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the money borrowed or debt incurred or in respect of any credit facility which has not been utilised.

Allaying the confusion as to whether interest on FCCB is similar to interest on any other loan, the authority has stated that the conversion of debt into equity is an option and not a mandatory ruling in the instrument. Therefore, under Section 195 (1), any person paying interest to a non- resident Indian or a foreign company is liable to deduct taxes.

Further, the ruling is of the view that interest payments on convertible debt cannot be interpreted as dividend income since dividend presupposes that the payee, or borrower in this case, holds shares in the company. On the other hand, the bond holder will become a shareholder only upon the conversion of bonds into equity shares.

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Juzer Sadikot (CA - innovative solutions for Imports and Exports) (1309 Points)
Replied 11 October 2009

Dear Mr. Jems,

I have prepared note on taxation of gain at the time of transfer of FCCB which offers zero coupon during life of FCCB and maturing at 30-40% accretion for my client which may prove useful to you. I have many investment option in said FCCB which yeild very attractive returns. Please contact to my email address juzer_juj @ yahoo.com if you are interested.

Interest shall be taxable as said by Mr. Rajeev.

Taxation on FCCBs

ð Facts;

1) A Non Resident transfer FCCB by following mode;

a. Sale to another non resident outside India without bringing money to India

b. Transfer on Maturity to Issuing Company

c. Transfer to another person resident in India.

d. Conversion into Ordinary Shares/GDR

2) Offered products have maturity ranging in different dates but not later than 1^st October 2012.

3) It is assumed that FCCBs are acquired after 1^st October 2009.

4) The coupon rate is “Zero”.

ð Test of Scope of Taxability;

Section 9 takes care of scope of taxability of FCCB in India for all “a”, “b” and “c”.

ð Taxability of Capital Gains at the time of transfer (Section 45);

a. Not Taxable. Section 47(viia) excludes the transaction of transfer of FCCB by Non-Resident to Non-Resident

b. Taxable in India and tax shall be deducted by Issuing Company

c. Taxable in India and tax shall be deducted by Resident buyer.

d. Not Taxable. Section 47(xa) excludes the transaction of conversion of FCCB to shares or debentures of any company.

ð Type/nature of Capital Assets for offered products (section 2(42A) and Rate of Taxation (Section 115AC and First Schedule of Finance Act*).

a. Not applicable.

b. Short term capital Asset as it is held for not more than 36 months and shall be taxable at Slab rate.

c. Short term capital Asset as it is held for not more than 36 months and shall be taxable at Slab rate.

Note; if type/nature of Capital Assets is long term then it shall be taxable at the rate of 10% without having benefit of indexation, basic exemption limit (Rs. 1,60,000/-) and benefits of deduction under chapter VI-A.

* Finance Act 2013 or DTC whichever may be in force.

ð Does Zero Coupon Bond cover FCCB?

Zero Coupon Bonds are defined under section 2(48) of Income Tax Act 1961 which is as under;

(48) “zero coupon bond” means a bond—

(a) issued by any infrastructure capital company or infrastructure capital fund or public sector company or scheduled bank on or after the 1st day of June, 2005;

(b) in respect of which no payment and benefit is received or receivable before maturity or redemption from infrastructure capital company or infrastructure capital fund or public sector company or Scheduled bank]; and

Further rule 8B (3) of IT Rules 1962 specifies following;

(3) The Central Government, while specifying a zero coupon bond by notification in the Official Gazette shall satisfy itself that the following conditions are fulfilled, namely:—

(i) the period of life of the bond is not less than ten years and not more than twenty years;

(ii)…………………………..

In view of foregoing provision, it is understand that the Central Government has not notified concerned FCCB as Zero Coupon Bond as it issued for around 5 years (i.e. not 10 years or more than 10 years) and so concerned FCCB is not Zero Coupon Bond.

ð Relevant extract of applicable provisions for your ready reference

Income deemed to accrue or arise in India.

Section 9

(1) The following incomes shall be deemed to accrue or arise in India :—

(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

Section 45

(1) Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 54, 54B, 54D, 54E, 54EA, 54EB, 54F, 54G and 54H, be chargeable to income-tax under the head “Capital gains”, and shall be deemed to be the income of the previous year in which the transfer took place.

Section 47

Nothing contained in section 45 shall apply to the following transfers :—

(viia) any transfer of a capital asset, being bonds or Global Depository Receiptsreferred to in sub-section (1) of section 115AC, made outside India by a non-resident to another non-resident;

(xa) any transfer by way of conversion of bonds referred to in clause (a) of sub-section (1) of section 115AC into shares or debentures of any company

Section 2 (42A)

“short-term capital asset” means a capital asset held by an assessee for not more than [thirty-six] months immediately preceding the date of its transfer :

Provided that in the case of a share held in a company or any other security listed in a recognised stock exchange in India or a unit of the Unit Trust of India established under the Unit Trust of India Act, 1963 (52 of 1963) or a unit of a Mutual Fund specified under clause (23D) of section 10 or a zero coupon bond, the provisions of this clause shall have effect as if for the words “thirty-six months”, the words “twelve months” had been substituted.

Section 115AC.

(1) Where the total income of an assessee, being a non-resident, includes—

(a) income by way of interest on bonds of an Indian company issued in accordance with such scheme as the Central Government may, by notification in the Official Gazette*, specify in this behalf, or on bonds of a public sector company sold by the Government, and purchased by him in foreign currency; or

(b) …………………………….

(c) income by way of long-term capital gains arising from the transfer of bonds referred to in clause (a) or, as the case may be, Global Depository Receipts referred to in clause (b),

the income-tax payable shall be the aggregate of—

(i) ……………………..

(ii) the amount of income-tax calculated on the income by way of long-term capital gains referred to in clause (c), if any, at the rate of ten per cent; and

(iii) the amount of income-tax with which the non-resident would have been chargeable had his total income been reduced by the amount of income referred to in clauses (a), (b) and (c).

(2) ……………………..

(3) Nothing contained in the first and second provisos to section 48 shall apply for the computation of long-term capital gains arising out of the transfer of long-term capital asset, being bonds or Global Depository Receipts referred to in clause (c) of sub-section (1).

*Notification No. 28/2008 [F. No. 149/193/2007-TPL], dated 21-2-2008.

ð Further, to confirm our opinion, the same provisions are given in the Scheme of Issue of FCCB and Ordinary Shares (through DRM) Scheme, 1993 which are produced below;

Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme, 1993

Taxation on Foreign Currency Convertible Bonds.

8. (1) Interest payments on the bonds, until the conversion option is exercised, shall be subject to deduction of tax at source at the rate of ten per cent.

(2) Tax on dividend on the converted portion of the bond shall be subject to deduction of tax at source at the rate of ten per cent.

(3) Conversion of Foreign Currency Convertible Bonds into shares shall not give rise to any capital gains liable to income-tax in India.

(4) Transfers of Foreign Currency Convertible Bonds made outside India by a non-resident investor to another non-resident investor shall not give rise to any capital gains liable to tax in India.

I would like to have your comment on my efforts on above note.

Thanks

1 Like

Rajeev (www.rkmco.com) (985 Points)
Replied 11 October 2009

Great effort Juzer , really appreciated .

Juzer Sadikot (CA - innovative solutions for Imports and Exports) (1309 Points)
Replied 11 October 2009

Dear Rajeev Sir,

Thank you very much for appriciation.

Request you to give response on my other posting (if you come across to them or find time). I would try my best to improvise on your suggestions.

Regards

1 Like

CA Sidhi Gaur (Chartered Accountant) (247 Points)
Replied 05 November 2009

i also appreciate ur efforts Juzer...nice job

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Juzer Sadikot (CA - innovative solutions for Imports and Exports) (1309 Points)
Replied 05 November 2009

Dear Sidhi,

Thanx for gesture.

Regards

Juzer

Ranjit Singh (DY. Manager ) (52 Points)
Replied 26 August 2010

dear Juzer

i want to know , according to latest amendment PAN no. is cumpulsory other wise 20% tax has to be deducted , now what will we do in the case of FCCB holder who's Pan No. is not avaliable with us ....