Interest up to conversion of bonds into shares to be taxed as income: Advance Ruling

NEW DELHI. Authority for Advance Rulings (Income Tax) vide AIT-2008-386-AAR has ruled that the payment made to LMCC in the form of interest up to the date of conversion of bonds into equity shares is nothing other than interest paid on the money advanced to the applicant or the debt incurred by the applicant and it satisfies the definition of ‘interest’ under Section 2(28A) of the Act as well as Article 11.4 of the India-US DTAA and it is accordingly liable to be taxed as income of LMCC under the Act and under Art.11.2 of DTAA. 

LMN INDIA LIMITED (Name changed at the request of the applicant) ,a non-banking financial company incorporated in India, makes investments in various businesses in India and abroad in the form of securities including shares, stocks and debentures. For the purpose of funding its business activities in India, the applicant proposes to borrow money from LMCC USA by issuing fully convertible Bonds under the foreign direct investments schemes. A “Bond Subscription Agreement” was, therefore, entered into between the applicant and LMCC.  As per the Agreement, the Bonds (with the face value of Rs.10/- each) are convertible into equity shares at the end of 5 years from the date of the issue unless extended for a further period of 5 years in which case the conversion would take place at the end of 10 years. Applicant submitted that by virtue of conversion there will be constructive payment of borrowed money to the Bondholder.  The interest on the bonds is payable by the applicant in rupee currency in cash on half yearly basis irrespective of the fact that the applicant makes profits or not. The rate of interest is specified in the amended Agreement.  As per the Agreement, the Bonds are treated as debt instruments till their conversion into equity shares.  Until conversion the bonds will rank in priority to equity shares in the event of a winding up or liquidation of the applicant–company.  Moreover, upon conversion of bonds, the equity shares issued will rank pari passu with the existing equity shares.  The applicant submitted that LMCC does not have a permanent establishment or fixed base in India.

The applicant sought advance ruling to “ascertain the precise nature of interest payments” under the Income-tax Act and to know whether the applicant is obliged to deduct tax at source. The following questions were formulated for consideration:

Question 1. Whether the interest paid/payable to LMCC upto the date of conversion of bonds into equity shares has to be treated as interest on money borrowed or debt incurred within the meaning of Section 2(28A) of the Act and under Article 11 of the India-USA DTAA and accordingly, liable to be taxed as ‘income’ under the Income-tax Act, 1961.

Question 2. Whether such payment constitutes expenditure incurred by the applicant in connection with raising capital or any other payment being compensation to LMCC during the pre-conversion period, which would be business income/receipts not attracting tax under the provisions of the DTAA between India and USA.

Question 3. Whether the aforesaid payments should be treated as dividend income of LMCC and such income is exempt under section 10(34) of the Act?

Question 4. Whether the applicant is liable to deduct tax at source under the Act in respect of the above transactions and if so, at what rate?

T H E   R U L I N G:

 

Question No.1. The payment made to LMCC in the form of interest up to the date of conversion of bonds into equity shares is nothing other than interest paid on the money advanced to the applicant or the debt incurred by the applicant and it satisfies the definition of ‘interest’ under Section 2(28A) of the Act as well as Article 11.4 of the India-US DTAA and it is accordingly liable to be taxed as income of LMCC under the Act and under Art.11.2 of DTAA.  In effect, the question is answered in the affirmative by upholding the contention of the assessee.

Question No.2. The first part of the question need not be answered because we are not concerned with the tax liability of the applicant and whether it can claim deduction of interest paid as expenditure under S.37 or S.36(1)(iii) of the Act.  We are only concerned with the non-resident’s liability which has been clarified above.

The second part of the question does not really arise for consideration  in view of our answer to question no.1.

Question No.3. It admits of no doubt that the interest payments cannot be construed as dividend income of LMCC.  Dividend pre-supposes that the payee holds shares in a Company. The bondholder LMCC would become shareholder only upon conversion of the bonds into equity shares. Further, there are express provisions in the Agreement to the effect that the Bondholders will not have any rights as shareholders of the applicant-Company until and unless the conversion takes place. Moreover, dividend can only be paid out of profits (vide Sec. 205(1) of Companies Act) whereas in the present case, interest is payable to the bondholder irrespective of whether the applicant makes profit or not. Hence, this question is answered in the negative.

Question No.4: Under Section 195(1) of the Act, the applicant is liable to deduct tax at source at the applicable rates inasmuch as the interest paid to LMCC is chargeable to income tax in India.

As regards the rate of tax, the applicant made it clear in the course of arguments and in the written submissions that the question may be left open so that the assessing authority will decide it in an appropriate proceeding.  Hence, no ruling regarding the rate of tax needs to be given.

(Click here for full text of Ruling AIT-2008-386-AAR)

 

(Source: allindiantaxes)

 

 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: