A Supreme Court ruling earlier this week will bring greater certainty on the tax treatment of Foreign Currency Convertible Bonds (FCCBs), making them more attractive to investors.

On Tuesday, while dismissing a Special Leave Petition by the revenue department against an earlier Bombay High Court judgement, the apex court turned down the department’s assertion that the date of purchasing the bonds should determine the cost of acquisition.

“The SC decision affirms the tax position of the 1993 Scheme, which covered both FCCBs and ADRs/GDRs. The tax certainty will make FCCBs more attractive to investors as well as issuers,” said Sunil Badala, Partner and Head, Financial Services, Tax, KPMG in India.

As per the 1993 Scheme, the price of the shares on the conversion date is to be considered the acquisition cost.

Say the FCCB was priced at $5, which turned into $10 on the date of conversion of the bond into shares. The cost of acquisition will be considered as $10 and not the original price of purchasing the bond. This implies there is a step-up of cost on the date of conversion.

The matter pertained to Kingfisher Capital’s subscription to Zero Coupon FCCBs in the Indian company NBVL in 2006 and the subsequent sale of shares received from the conversion of these FCCBs.

The apex court on Tuesday observed that the bonds were issued under the 1993 Scheme, which governs the issuance of FCCBs, and not the 2008 Scheme, which pertains to Foreign Currency Exchangeable Bonds.

“The special taxing provisions were introduced in 2008, which should not apply to the FCCBs issued in 1993. In absence of such specific taxing provisions, the tax treatment provided by the 1993 Scheme would legitimately apply,” said Punit Shah, partner, Dhruva Advisors. “This will clear the doubts regarding the taxability of gains on 1993 Scheme bonds and mitigate future litigation.”

FCCBs and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme was notified in 1993 to allow Indian companies to raise money overseas through the issue of FCCBs and Global Depository Receipt Mechanism (GDR) and American Depository Receipt Mechanism (ADR).

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The Bombay High Court had earlier ruled that the computation of capital gains should be determined from the date of conversion of FCCBs into shares and not the date of acquisition of the FCCBs. This was challenged by the revenue department.

Indian companies issue FCCBs abroad to raise money in foreign currency.

What is an FCCB?
It is a special type of debt instrument issued in foreign currency
It is a bond with a dual character of debt and equity instrument
It acts like a bond making regular coupon and principal payments and provides investors with an option to convert them into equity
Upon maturity, holders can convert the equivalent value of equity at a set conversion rate