The Hindu Business Line : ‘Cost’ shifts in FCCB taxation to worry FIIs

Chennai, April 11 Cost of acquisition of shares received upon conversion of bonds into shares shall be the price at which the corresponding bonds were purchased.

The above statement may seem innocuous to a lay reader, but not so to those who deal with convertible bonds, including the FIIs (foreign institutional investors), who now have to rework the taxes.

“Since the proposed amendment is to be made effective retrospectively, from assessment year 2008-09, taxpayers including the FIIs will need to revise their taxes already paid for the last financial year (2007-08) and make good the shortfall,” says Mr Kamlesh Chainani, Director, Deloitte Haskins & Sells, Mumbai.

“Hitherto, the cost of the FCCBs (foreign currency convertible bonds) was not considered as part of the cost of acquisition of shares for the purpose of computing capital gains; it was only the market price of shares prevailing on the date of conversion that was considered,” he explains, during a recent e-mail interaction with Business Line. “With this proposed amendment, the cost of the FCCBs will be deemed to be the cost of acquisition of shares.”

Drawing attention to the fact that there is no amendment as regards the period of holding of shares, Mr Chainani observes, “Even though the cost of shares is being related back to the cost of the bonds for the purpose of computing capital gains on sale of shares, the period for which the bonds were held by the taxpayer is being ignored, which is uncalled for and not justified on the grounds of equity.”

Excerpts from the interview.

On the existing law.

Currently, any transfer on conversion of bonds or debentures, debenture-stock or deposit certificates into shares or debentures is not treated as “transfer” under the provisions of section 47(x) of the Income-tax Act, 1961 and hence not liable to capital gains tax.

Though the conversion of bonds was originally not covered under the above provision, the same was later on inserted by the Finance Act, 1992, with retrospective effect from April 1, 1962.

Support in this regard was also obtained from para 8(3) of the Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993 (‘Depository Receipt Scheme’), as notified by the Government, which specifically provided that conversion of FCCBs into shares shall not give rise to any capital gains liable to income-tax in India.

On the practice thus far.

Based on the above provisions, the taxpayers, including the FIIs took a position that any transfer by way of conversion of FCCBs into shares was not liable to capital gains tax.

Similarly, in terms of para 7(4) of the Depository Receipt Scheme, for the purpose of computing capital gains tax on the sale of the shares, the cost of acquisition of the shares received upon conversion of the FCCBs would be the market price of the shares on the Bombay Stock Exchange or the National Stock Exchange as on the date of conversion.

However, there is no corresponding provision in the Income-tax Act, 1961 as to the cost of acquisition of the shares being the price prevailing on the date of conversion as explained above.

Based on the provisions of the Depository Receipt Scheme, the taxpayers, including the FIIs, compute the capital gains on sale of shares by adopting the market price prevailing on the date of conversion as the cost of acquisition.

On the proposed change, with an example.

The Finance Bill, 2008 has now proposed to substitute sub-section (2A) of section 49 with retrospective effect from April 1, 2008 (i.e. assessment year 2008-09) to provide that cost of the acquisition of the shares received upon conversion of bonds into shares shall be the price at which the corresponding bonds were purchased.

Consider, for example, a situation where the sale consideration of shares is Rs 1,000; cost price of FCCB Rs 100; and the market price of shares prevailing on the date of conversion Rs 500. While, in the existing scenario, capital gains work out to Rs 500, the same would be Rs 900, as per the proposed amendment.

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