By Geeta Jani, Dhishat B. Mehta, Chartered Accountants
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Part C — International Tax Decisions
7 LMN India Limited
In re
[No. 769 of 2007] (AAR)
S. 2(28A), S. 90 of IT Act; Article 11 of India-USA DTAA
Dated : 10-10-2008
Issue :
Interest paid to a non-resident investor on fully and
compulsorily convertible bonds till the date of conversion is taxable in India
as interest.
Facts :
The applicant, a non-banking financial company of India, had
issued fully convertible bonds to LMCC of USA.
As per the Bond Subscription Agreement :
(a) The bonds were convertible into equity shares at the
end of five years from the date of issue.
(b) Interest was payable on the bonds on half-yearly basis,
irrespective of whether the applicant made profits or not.
(c) Until conversion, the bonds were to be treated as debt
instruments.
(d) The bonds ranked in priority to equity shares in the
event of winding-up/liquidation of the applicant-company.
(e) Upon conversion, the equity shares issued were to rank
pari passu with the existing equity shares.
The basic issue before the AAR was about tax implications and
consequential withholding tax obligation in respect of interest paid/payable to
the investor up to the date of conversion of bonds into equity shares.
Held :
Payment made to LMCC of USA up to the date of conversion of
bonds into equity shares was held to be interest in terms of definition of
‘interest’ u/s. 2(28A) of the IT Act as well as under the India-USA DTAA.
The AAR noted that under the IT Act, the term ‘interest’ is
defined in a broad manner to include interest payable in any manner in respect
of any moneys borrowed or debt incurred. Under the India-USA DTAA, it is defined
to mean income from debt claims of every kind, including income from bonds or
debentures.
Payment of interest pre-supposes borrowal of money or the
incurring of a debt. Raising of funds by means of fully convertible debenture is
a well-known commercial and business practice. Debenture creates or recognises
existence of a debt which remains to be so till it is repaid or discharged.
The convertibility of debentures does not affect its
characteristic feature of being a debt. The AAR held that conversion was the
mode of discharging the debentures and the debt would be extinguished on handing
over the fully-paid equity shares at the agreed price and at the agreed time to
the bondholder. The Supreme Court’s decisions in the case of CWT v. Spencer &
Co., (1973) 88 ITR 429 (SC) and Eastern Investments Ltd. v. CIT,
(1951) 20 ITR 1 (SC) were relied upon to support the proposition.
