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2025 (6) TMI 1930 - AT - Income TaxTaxability of interest income earned on CCDs and OCDs - applicability of the concessional tax rate of 5.46% (including applicable surcharge and cess) -provisions of section 194LD applicability on CCD and OCD as falls in the category of Rupee denominated bond of an Indian company HELD THAT - Revenue does not dispute that the interest rate on the respective OCDs and CCDs does not exceed the maximum interest rate notified by the Central Government being 500 basis points over the base rate of State Bank of India. Thus it can be concluded that the interest rate condition is also satisfied in the present case in respect of the respective OCDs and CCDs issued by the Indian AEs. Is if CCD and OCD fall in the category of Rupee denominated bond of an Indian company so the provisions of section 194LD of the Act becomes applicable - The rights and obligation of debentures in general would mutatis mutandis be applicable to the OCDs / CCDs prior to their conversion. The only uncertainty in the OCDs is whether the debenture holder will go for conversion into shares or will continue to hold them as debentures. This uncertainty in no way impacts the inherent nature of the instrument. The nature rights and obligations attached to OCDs / CCDs cannot be equated with that of shares until conversion thereof till then OCDs / CCDs retain the character of a debenture simplicitor. We are of further considered view that as for the purpose of Section 194LD what is important is that the security should be rupee denominated one. Intention being that Indian company does not bear any risk out of foreign exchange fluctuation at the time of repayment of the principal or the interest amount. The distinction between OCD/CCD with NCD is of no consequence and they are debt instrument only like the bonds. Bond as a security when distinguished from the debentures only is for the purpose of signifying that bonds may at times be backed up by some collateral security while same is not the case when the debentures are issued. To treat CCD and OCD as shares in praesentia would be extending too far the principles of interpretation and infact the purposive interpretation would require extending benefit to the assessee as long as the OCD/CCD are rupee denominated when investment is sought or interest is paid. Thus Tax Authorities have fallen in error to not give the assessee the benefit of Section 194LD in regard to OCD/ CCDs also. It appears that ground was specifically raised before the ld DRP but no specific direction in that regard was made and while passing the final assessment order the AO has gone by the limited directions of the ld DRP with regard to NCDs only. Thus we are inclined to sustain the grounds in favour of the assessee.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered by the Tribunal are:
2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Applicability of concessional tax rate under section 194LD to interest income on OCDs and CCDs Relevant legal framework and precedents: Section 115A(1)(a)(BA)(ii) of the Act provides for a concessional tax rate on interest income earned by specified foreign investors on rupee denominated bonds issued by Indian companies. Section 194LD mandates deduction of tax at source at this concessional rate (5.46% including surcharge and cess) on such interest income. The conditions include that the interest is payable to Foreign Institutional Investors (FIIs) or Qualified Foreign Investors (QFIs), within a specified time frame, on rupee denominated bonds or government securities, and the interest rate does not exceed the notified maximum. The terms "bond" and "debenture" are not defined in the Income Tax Act. However, the Companies Act, 2013 defines "debenture" to include debenture stock, bonds, or any other instrument evidencing a debt. Judicial precedents have held that bonds and debentures are debt instruments and the terms are often used interchangeably. The Delhi Tribunal in Heidelberg Cement AG held that non-convertible debentures (NCDs) qualify as bonds for the purpose of section 194LD. The Hon'ble Supreme Court in R.D. Goyal v. Reliance Industries Ltd. distinguished debentures from shares, emphasizing that debentures are instruments evidencing debt, whereas shares represent ownership. Court's interpretation and reasoning: The Tribunal examined whether OCDs and CCDs, prior to conversion, retain the character of debt instruments akin to bonds or debentures. It noted that the rights and obligations attached to OCDs and CCDs differ significantly from shares until conversion. For instance, debenture holders are creditors without voting rights, have priority in winding up, and hold a charge over company assets, unlike shareholders who are owners with voting rights and residual claims. The Tribunal relied on the Companies Act provisions and judicial decisions to establish that OCDs and CCDs are distinct from shares and constitute debt until conversion. It emphasized that the payment of interest presupposes indebtedness, and conversion at a later date is a constructive repayment of debt. The uncertainty over whether OCD holders will convert does not alter the inherent debt nature of the instrument. Further, the Tribunal considered the purpose of section 194LD, which is to provide concessional tax treatment on rupee denominated debt securities issued by Indian companies to foreign investors, thereby mitigating foreign exchange risk. It held that the distinction between NCDs and convertible debentures (OCDs/CCDs) is immaterial for this purpose, as both are rupee denominated debt instruments. Key evidence and findings:
Application of law to facts: The Tribunal applied the definitions and judicial precedents to conclude that OCDs and CCDs are debt instruments until conversion, qualifying as rupee denominated bonds under section 194LD. Consequently, interest income on these instruments should be eligible for the concessional tax rate of 5.46%. Treatment of competing arguments: The Revenue argued that section 194LD applies only to rupee denominated bonds and not debentures, and that OCDs and CCDs are akin to shares, not debt. The Tribunal rejected this, distinguishing shares from debentures and emphasizing the debt nature of OCDs/CCDs prior to conversion. The Tribunal also noted that the AO and DRP erred in limiting the benefit only to NCDs, ignoring the broader statutory and judicial context. Conclusions: The Tribunal held that the interest income on OCDs and CCDs qualifies for the concessional tax rate under section 194LD and directed the Assessing Officer to grant the benefit accordingly. Issue 2: Error in computation of aggregate tax and interest liability for AY 2021-22 Relevant legal framework and precedents: The assessment order for AY 2021-22 involved computation of tax and interest liability based on the tax rates applicable to interest income. The correctness of the tax rate applied affects the demand raised. Court's interpretation and reasoning: The Tribunal observed that the Assessing Officer applied an incorrect tax rate without providing a basis, resulting in an inflated demand. The issue was not disputed by the DRP. Key evidence and findings:
Application of law to facts: In light of the Tribunal's finding on Issue 1 that OCDs and CCDs qualify for concessional tax rate, the tax computation must reflect this. The AO was directed to apply the correct tax rate accordingly. Treatment of competing arguments: The Revenue did not dispute the facts regarding the incorrect tax rate application, and the Tribunal found no merit in the AO's computation. Conclusions: The Tribunal allowed the ground raised by the assessee and directed the AO to recompute tax and interest liability applying the correct tax rate consistent with the decision on Issue 1. 3. SIGNIFICANT HOLDINGS "In the absence of any specific definition of bonds in the Income-tax Act or in Section 194LD, the term 'bonds' used in the section should be considered as including non-convertible debentures." "The nature, rights and obligations attached to OCDs / CCDs, cannot be equated with that of shares until conversion thereof; till then OCDs / CCDs retain the character of a debenture simplicitor." "The payment of interest presupposes the fact that money has been borrowed or a debt has been incurred. The obligation to repay the amount is embedded in the concept of debt, the repayment need not be in the form of cash, it could be in kind. Conversion of bonds into fully paid-up equity shares at the end of the specified period at the conversion price amounts to constructive repayment of debt." "For the purpose of Section 194LD, what is important is that the security should be rupee denominated. The distinction between OCD/CCD with NCD is of no consequence and they are debt instruments only like the bonds." "The Assessing Officer erred in not granting the benefit of concessional tax rate under section 194LD to interest income on OCDs and CCDs." "The Assessing Officer applied an incorrect tax rate resulting in an inflated demand. The AO is directed to recompute tax and interest liability applying the correct tax rate in light of the decision on the nature of OCDs and CCDs." The Tribunal allowed the appeals for both assessment years with consequential directions to the Assessing Officer.
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