Clarity on tax implications in respect of rupee denominated bonds
With a view to facilitate rupee denominated borrowings from outside India, the Reserve Bank of India (RBI) issued guidelines in September 2015 wherein it permitted Indian companies [as well as Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)] to issue rupee denominated bonds (or masala bonds as they are typically referred to) within the overarching External Commercial Borrowings (ECBs) policy.
Though the bonds were to be issued within the ECB policy framework which prescribed numerous stringent requirements for borrowings from outside India, the aforesaid RBI guidelines relaxed such requirements of the ECB policy and provided a lot of flexibility in terms of eligible borrowers, investors, all-in-cost ceilings, end uses, etc. for rupee denominated bonds.
In other words, pursuant to the RBI guidelines, Indian corporates (and REITs as well as InvITs) could proceed to raise funds outside India by issuing rupee denominated bonds without complying with the onerous requirements typically applicable to other forms of ECBs.
The RBI further relaxed its requirements in April 2016 when it reduced the minimum maturity period for rupee denominated bonds to 3 years instead of 5 years earlier. This relaxation was provided in order to align with the maturity prescribed for foreign investment in corporate bonds through the Foreign Portfolio Investment (FPI) route.
In order to provide a fillip from an income-tax perspective and to support the RBI in this initiative of promoting rupee denominated borrowings from outside India, the Central Board of Direct Taxes (CBDT) i.e. the apex administrative body for direct taxes in India, issued a press release dated 29thOctober 2015 to provide clarity on certain tax related aspects pertaining to these rupee denominated bonds.
Specifically, as per the said press release,
• a concessional withholding tax rate of 5% (which would be in the nature of a final tax) on interest payments to non-resident investors of rupee denominated bonds; and
• exemption from capital gains tax for capital gains, if any, arising in case of appreciation of rupee between the date of issue and the date of redemption of the rupee denominated bonds was proposed.
While the press release indicated that legislative amendments with respect to the above tax implications would be provided in Finance Act, 2016 (FA 2016), the said Act, which received the assent of the President on 14 May 2016, only provided for capital gains tax exemption to the "subscriber" of rupee denominated bonds. The FA 2016 did not provide for any withholding tax rate on interest payments to investors in rupee denominated bonds.
As a result of the above amendments by FA 2016, a lot of ambiguity arose in case of rupee denominated bonds, especially with respect to:
• the applicable withholding tax rate in case of interest payments to non-resident investors of rupee denominated bonds; and
• whether capital gains tax exemption for gains, if any, arising on rupee appreciation was only available to a "subscriber" of rupee denominated bonds (and not to a subsequent transferee / buyer of such bonds).
In the absence of a specific withholding tax rate, a view was being adopted that the applicable tax withholding tax should be as high as 40% (subject to any beneficial tax treatment provided in a Double Taxation Avoidance Agreement, if any, applicable to the non-resident investor). In certain other cases, reliance was proposed to be placed on the press release of CBDT for a withholding tax rate of 5%.
Proposal in Budget 2017
The Finance Bill 2017 presented by the Finance Minister on 1 February 2017 provides a lot of clarity on the tax implications for rupee denominated bonds. As per the amendments proposed by the Finance Bill 2017,
• A withholding tax rate of 5% will apply on interest payments by Indian company, REIT or InvIT to a non-resident investor in rupee denominated bond issued outside India before 1 July 2020; and
• Any gains arising on account of appreciation of rupee against a foreign currency at the time of redemption of rupee denominated bond of an Indian company "held" by a non-resident, shall be ignored for the purposes of computation of capital gains.
Thus, the benefit is proposed to be provided to not only the original "subscriber" but also to a subsequent transferee / buyer.
It would be relevant to note that the beneficial withholding tax rate as indicated above is proposed to be introduced from Financial Year 2015-16.
Other amendments in respect of rupee denominated bonds are:
• A transfer (made outside India) of a rupee denominated bond of Indian company issued outside India, by a non-resident to another non-resident, shall not be regarded as a transfer for the purpose of levy of capital gains tax
• Concessional rate of 5% withholding tax on interest payment to a Foreign Institution Investor or a Qualified Foreign Investor in respect of investments in Government Securities or rupee denominated corporate bonds to be made available on interest payable before 1 July 2020 (instead of 1 July 2017 earlier)
The amendments proposed by Finance Bill 2017 are a welcome move by the Government of India. This will incentivise the Indian companies to borrow / raise funds from outside India and support initiative like "Make in India", "Start up India" etc. of the Government of India.