TMI Blog2008 (10) TMI 21X X X X Extracts X X X X X X X X Extracts X X X X ..... ses to borrow money from LMCC USA by issuing fully convertible Bonds under the foreign direct investments schemes. A Bond Subscription Agreement was, therefore, entered into between the applicant and LMCC (referred to as 'investor'). As per the Agreement, the Bonds (with the face value of ₹ 10/- each) are convertible into equity shares at the end of 5 years from the date of the issue unless extended for a further period of 5 years in which case the conversion would take place at the end of 10 years. Applicant submits that by virtue of conversion there will be constructive payment of borrowed money to the Bondholder. The interest on the bonds is payable by the applicant in rupee currency in cash on half yearly basis irrespective of the fact that the applicant makes profits or not. The rate of interest is specified in the amended Agreement. The applicant further submits that as per the Agreement, the Bonds are treated as debt instruments till their conversion into equity shares. Until conversion the bonds will rank in priority to equity shares in the event of a winding up or liquidation of the applicant-company. Moreover, upon conversion of bonds, the equity shares i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s income from debt-claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities, and income from bonds or debentures, including premiums or prizes attaching to such securities, bonds, or debentures .. 3.1. Both the definitions are substantially similar. However, Article 11(4) specifically includes income from bonds or debentures within the ambit of 'interest'. 4. We shall now refer to the relevant clauses in the Bond Subscription Agreement. In the recital, it is stated that the company is in need of working capital / funds for the purposes of its business in India and the investor (LMCC) has expressed its willingness to extend financial assistance by subscribing to Bonds in the nature of promissory notes of the face value of ₹ 10/- each. The maximum amount of investor's subscription to the Bonds is stated to be ₹ 8,000 crores. 4.1. The definition of 'Bonds' and 'Conversion' may be noticed. Bonds shall mean Series A fully convertible Bonds issued by the company (applicant) of the face value o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its or not. All payments of interest shall be subject to withholding tax at the applicable rate. While Art. 4.2.1 stipulates that the Bonds maintained in physical form shall be transferable by the investor to any third party purchaser for value by endorsement and delivery and the transfer becomes effective when the applicant passes an appropriate resolution. Art. 4.2.2 states that only the Bondholders as are registered in the register of Bond holders/ register of beneficial holders shall be entitled to payment of interest in their name. Article 5.1 specifies that the Bond holder shall apply the amount receivable on redemption of Bonds by subscribing to fully paid up equity shares of the company in the specified manner. Article 6 says that until conversion, the Bondholders shall be entitled to the rights of the secured/unsecured creditors of the company as provided under the Companies Act, including the right to receive interest on due date and the right to receive proceeds on redemption of Bonds on the due date. Prior to conversion, the Bondholders shall not be entitled to any of the rights of the holders of equity shares such as voting rights (Art.6.2). 5. In our view, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nowledgement of a debt - and speaking of the numerous and various forms of instrument which have been called debentures without anyone being able to say the term is incorrectly used, I find that generally, if not always, the instrument imports an obligation or covenant to pay. This obligation or covenant is in most cases at the present day accompanied by some charge or security. The High Court then observed that in the ordinary business sense, a debenture is generally understood to be a document ., acknowledging a debt and securing repayment thereof by mortgage or charge on the Company's property and providing that until repayment, interest will be paid thereon at a fixed rate usually either half-yearly or on fixed dates . The High Court further clarified that redemption is a method by which the Company obliterates its obligation to repay its debt to the debenture-holders or debenture stockers or by itself repurchasing the debentures. In Laxman Bharmaji vs. Emperor (AIR 1946, Bombay, 18), a division Bench of Bombay High Court pointed out that notwithstanding the fact that the bonds are not styled as debentures, the substance of the instrument has to be looked i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of interest pre-supposes the borrowal of money or the incurring of a debt. That is what the definition of 'interest' in specific terms states. The question to be asked and answered is whether the money has been borrowed by the applicant and the amount paid by way of interest is directly related to that money. The allied and integral question is whether by reason of execution of debenture bonds for the moneys advanced to it, the applicant incurred a debt? It admits of no doubt that these questions should be answered in the affirmative. Issuance of debentures is a mode of borrowing money. The raising of funds by means of fully convertible debentures is a well known commercial and business practice. Debenture, as already noted, creates or recognizes the existence of a debt which remains to be so till it is repaid or discharged. The interest relates to the debt which the applicant incurred by getting the funds requisite for its business from LMCC. Does it cease to be a debt merely because the bonds are redeemed not by returning the money but by getting shares of the equivalent value Does convertibility of debentures affect the characteristic of debt and transform it into som ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that if the debentures were held by a third party, the interest payable on the same would be an allowable deduction in calculating the total income of the assessee company. What difference does it make if the holder of the debentures is a shareholder? There appears to be none in principle in view of the fact that no suggestion of fraud is made in respect of the transaction. If the debentures had been paid for in cash by the same party, no objection could have been taken to allowing the interest amount to be deducted. In principle, there appears to us no difference, if instead of paying in cash the payment of the price is in the shape of giving over shares of the company when the transaction is not challenged on the ground of fraud and is approved by the Court 7.2. The underlined portions of the passage extracted above will emphasize that even if the amount covered by debentures is repayable in the shape of giving over the shares of the company, it does not make any difference for allowing deduction of interest paid on the money borrowed by way of debentures. 8. Basically what happens is that the money is advanced to the applicant as a financial package fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd. vs. ACIT (100 ITD 247) to steer clear of the alleged uncertainty brought out by the said decision in addressing the present controversy. The question that arose in Ashima Syntex was whether the expenditure incurred by the assessee for issuing convertible debentures was other than capital expenditure so as to qualify for deduction u/s 37 of the Act. The Tribunal held that the substance of the transaction was that of raising capital base of the Company and therefore it would be capital expenditure even if the capital was meant to be used for business purposes. It was observed that convertible debenture is in the nature of an advance or deposit akin to share application money as there is no repayment of money but the amount is adjusted towards shares compulsorily and interest is paid on that until shares are allotted . It is seen that the Tribunal was not concerned with the interest payments and the deduction claimed was not under S.36 (1)(iii) of the Act. There was no occasion to construe and apply the definition of 'interest' as per S.2(28-A) of the Act and Art. 11.4 of DTAA. Hence, strictly speaking, the ratio of the said decision is not applicable to the prese ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12. In the light of above discussion, the questions set out at page 3 are answered as follows : Question No.1. The payment made to LMCC in the form of interest up to the date of conversion of bonds into equity shares is nothing other than interest paid on the money advanced to the applicant or the debt incurred by the applicant and it satisfies the definition of 'interest' under Section 2(28A) of the Act as well as Article 11.4 of the India-US DTAA and it is accordingly liable to be taxed as income of LMCC under the Act and under Art.11.2 of DTAA. In effect, the question is answered in the affirmative by upholding the contention of the assessee. Question No.2. The first part of the question need not be answered because we are not concerned with the tax liability of the applicant and whether it can claim deduction of interest paid as expenditure under S.37 or S.36(1)(iii) of the Act. We are only concerned with the non-resident's liability which has been clarified above. The second part of the question does not really arise for consideration in view of our answer to question no.1. Question No.3. It admits of no doubt that the interest payments can ..... X X X X Extracts X X X X X X X X Extracts X X X X
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