The Hindu Business Line : FCEB: The new `bond' on Mint Street

The name of the new `bond' on the Mint Street is FCEB or the `foreign currency exchangeable bond'. Recently notified by the Finance Ministry, the FCEB Scheme, 2008, enables Indian promoters to unlock value in their group companies, without immediate dilution of voting power or control in such companies, explains Mr Rakesh Dharawat, Executive Director, Tax and Regulatory Services in PricewaterhouseCoopers, Mumbai.

"The unique and flexible nature of FCEB has generated a lot of interest among large Indian corporate houses looking to raise funds overseas, for acquisitions or greenfield projects," he adds, during the course of an e-mail interaction with Business Line.

Clearly the introduction of FCEBs is a very laudable initiative and provides an additional avenue for Indian promoters to raise funds from foreign investors to fund new projects or acquisitions, observes Mr Dharawat.

"One now looks forward to a smooth implementation of the scheme by the nodal agency - the RBI (Reserve Bank of India)."

Excerpts from the interview:

First, a definition of FCEB.

FCEB is a foreign currency bond, issued by an Indian issuing company (IC) and subscribed to by a person who is a resident outside India. FCEBs are exchangeable into equity shares of an offered company (OC).

Who can issue and invest?

IC must be an Indian company, which:

Is part of the promoter group of OC;

Holds the offered shares in OC; and

Is eligible to raise funds from the Indian securities market.

Non-corporate entities (such as trusts, individual and firms) are not permitted to issue FCEBs.

OC should be an Indian listed company, which:

Is engaged in a sector eligible to receive foreign investment; and

Is eligible to issue/avail FCCB (foreign currency convertible bond) or ECB (external commercial borrowing).

Investor can be any person resident outside India who is permitted to invest in OC, under the FDI (foreign direct investment) policy.

Where can the FCEB proceeds be deployed?

The FCEB proceeds can be invested by IC in:

Overseas, in joint ventures/subsidiaries (including acquisitions);

In promoter group company. The promoter group company would have to comply with the end-use restrictions prescribed in ECB Regulations.

FCEB proceeds cannot be invested in real estate and capital market.

The FCEB scheme does not mandate that the investment in group companies should necessarily be by way of equity.

Also, the scheme does not provide for any specific rupee expenditure limit.

Are any approvals required?

An FCEB issue would require the following approvals:

From the RBI, by IC.

From the FIPB (Foreign Investment Promotion Board), if the investment in OC is not under the automatic route.

From IC's board and shareholders, as per company law.

From OC's board.

Can you explain how FCEB redemption/exchange works?

FCEBs provide an option to the investor for redemption or exchange into shares of OC. The minimum maturity period for redemption must be 5 years.

Exchange option can be exercised any time before redemption.

Investors are freely permitted to sell OC shares received upon exchange; however, cash settlement upon exchange is not permitted.

The minimum benchmark exchange price shall be higher of 2-week or 6-month average weekly closing prices of OC, with reference to the board resolution date of IC.

In line with the ECB guidelines, all in-service cost for FCEBs shall not exceed Libor (London inter bank offer rate) plus 250 bps (basis points).

Any negative covenants on IC?

The offered shares shall be kept free from all encumbrances. IC cannot transfer, mortgage, make collateral offer of, or trade in, OC shares offered as part of FCEB issue, till its redemption/exchange.

What are the tax provisions governing FCEBs?

The scheme provides for the tax treatment of FCEBs. Besides, the Finance Bill, 2008 proposes new Section 47(xa) and amendments to Section 49(2A) of Income Tax (IT) Act, relating to FCEB taxation.

Essentially, FCEB interest payments shall attract tax withholding at 10 per cent, as per Section 115AC of IT Act.

A non-resident should be eligible to claim treaty benefits, based on his country of tax residence.

This could be relevant to investors such as foreign banks and government institutions.

Whilst the scheme provides for taxation of dividends on exchanged portion of FCEB as per Section 115AC, considering that OC would have paid dividend distribution tax, the investor should not be taxed again thereon.

The scheme specifically provides that transfer of FCEBs between non-residents shall be exempt from tax in India.

The new Section 47(xa) exempts from capital gains tax any transfer by way of conversion of FCEBs into OC shares. The Section, as proposed, only seems to exempt the investor who exchanges the FCEB for OC shares.

The proposed Section does not apply to capital gains arising in the hands of IC, upon transfer of OC's shares to the investor as part of exchange.

Section 49(2A) provides that the cost of acquisition of OC shares acquired upon exchange shall be proportionate to the cost of original FCEB.

It may be relevant to mention that the FCEB scheme needs to be specifically notified under Section 115AC of IT Act before one could reap the above benefits.

Would IC get interest deduction?

The deductibility of interest payments in the hands of IC would be subject to funds being utilised for the purpose of its business, as mandated under Section 36(1)(iii) of the IT Act.

Considering that IC could invest such funds in group companies, the impact of the said condition would have to be evaluated. Further, where IC makes equity investment in group companies (the dividends from which are tax exempt), the provision of Section14A of the IT Act would also impact the claim.

The foreign currency exchangeable bond enables Indian promoters to unlock value in their group companies, without immediate dilution of voting power or control in such companies.

Bio: Mr Dharawat, a Fellow Member of the Institute of Chartered Accountants of India, has over 20 years of consulting experience in direct tax and regulatory matters. Apart from representing clients before tax authorities at all levels, he has advised several multinational companies on various aspects of domestic and cross-border taxation, tax treaty interpretation, and exchange control regulations.

http://InterviewsInsights.blogspot.com

D. MURALI

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