Gains on sale of compulsory convertible debentures taxable as interest, rules AAR

| Updated on: Apr 07, 2012

Gains made by a Mauritius company by selling compulsory convertible debentures (CCDs) to an Indian company are taxable as interest in India.

Taking this stand, the Authority for Advance Rulings (AAR) has said that any gains made by selling such instruments will not be eligible for capital gains exemption under the India-Mauritius tax treaty.

Simply put, withholding tax obligations would arise on the Indian company making the payment as consideration for the CCDs.

According to the experts, the Authority's decision is in line with the rulings of the Supreme Court and High Courts that CCDs are basically debt instruments.

By this ruling, the AAR has rejected the contention of an applicant that sale of CCDs is sale of assets and the premium received is not interest income, but capital gains.

‘Look at' test

To arrive at this ruling, the AAR also applied the “look at” test to ascertain the true legal nature of the transaction. For this, it relied on the Supreme Court commentary on legal relevance of subsidiaries and the principle of lifting of corporate veil laid down in the recent landmark Vodafone case.

The case before AAR involved three unnamed parties — V, an Indian entity; Z, a Mauritius-based company; and S, a subsidiary of V and based in India. V had transferred its right to develop a plot of land to its subsidiary S. Z had invested in S by purchasing equity and zero per cent CCDs. The CCDs were convertible at the end of six years from the first closing in November 2007.

In April 2010 and March 2011, V exercised a call option to purchase equity shares and CCDs from Z. V then approached the AAR to determine whether gains arising to Z from the sale of CCDs would be exempt from capital gains tax in India under the India-Mauritius treaty.

The AAR ruled that the method laid down in the shareholder agreement between Z, V and S is similar to the manner in which interest on any investment is calculated. The Authority ruled that the appreciation in the value of debentures is payment of interest, taxable under the India-Mauritius DTAA. Applying the ‘look at' test, the AAR concluded that V and S are parent and subsidiary only on paper. In reality, they are one and the same entity.


Published on March 12, 2018

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