Abbas Jaorawala & Kinjal Kapadia
Background and overview of Masala Bonds
Non-resident investors have recently shown a great deal of interest in subscribing to ‘Masala Bonds’ issued by Indian corporates. ‘Masala Bonds’ is the informal name of ‘Rupee-denominated bonds’ (RDB) issued by Indian corporates outside India. These bonds are attractive to both the issuer and the investor at the same time. For the issuer, the main benefit is to raise cheaper funds overseas while mitigating exchange fluctuation risk. For the investors, the Masala Bonds are an avenue to participate in Indian bonds without taking any formal registration with Indian authorities and earning comparatively better interest rates (as compared to their home countries).
In light of the above mentioned apparent benefits, many Indian corporates have / are contemplating raising funds through the Masala Bond route. They have been helped in this regard by the business-friendly policy of the Reserve Bank of India (RBI) governing issue of Masala Bonds.
Taxability of interest paid on Masala Bonds
However, while the regulatory framework for Masala Bonds has been quite clearly laid out, there was an ambiguity with regard to the taxation of the interest earned by the non-resident investors from these bonds for the past 1 year or so. While the expectation of the investor community was that interest from these bonds should be exempt from tax in India, Central Board of Direct Taxes (CBDT) had issued a Press Release in October 2015 clarifying that such interest would be subject to withholding tax of 5% (plus applicable surcharge and cess) in India.
In the said press release, it was also clarified that suitable amendment to this effect would be made in the Income-tax Act, 1961 (‘the Act’) by Finance Bill, 2016. However, neither the Finance Bill, 2016 nor the Finance Act, 2016 provided for any such amendment. This resulted in the following two views emerging on the taxability of interest on Masala Bonds:
View 1 – Withholding tax rate of 5% (plus applicable surcharge and cess) will apply as clarified by the CBDT, although there were no supporting provisions under the Act; or
View 2 – Withholding tax rate of 40% (plus applicable surcharge and cess) would apply [unless reduced by beneficial tax rate under any tax treaty].
Given the large variance between the possible withholding tax rates, it was important for the Government to make amends and provide certainty to investors in Budget 2017. Thankfully, the Finance Bill, 2017 now proposes to formally provide a concessional withholding tax rate of 5 per cent to RDBs (Masala Bonds) issued by an Indian company outside India by way of amendment to section 194LC of the Act.
To elaborate, Section 194LC as proposed to be amended by Finance Bill, 2017 provides that:
- interest paid to a non-resident taxpayer;
- on ‘rupee denominated bonds’ (i.e. Masala Bonds) of Indian companies issued before
1 July 2020; and - the interest rate is within the limits specified by the Government;
would attract withholding tax at concessional rate of 5% only (plus applicable surcharge and cess).
To address the ambiguity created by Finance Bill, 2016, the amendment is proposed to be made retrospectively applicable from 1 April 2015 itself. Accordingly, interest on Masala Bonds has been extended the same tax treatment as provided to foreign currency loans and certain ‘long-term bonds’.
Need for suitable amendment in Section 206AA
While the retrospective amendment in section 194LC is a very welcome step on part of the Government, a suitable consequential amendment under section 206AA of the Act appears to have been missed out as was earlier provided to ‘long-term bonds’.
Section 206AA of the Act currently provides that where the applicable withholding tax rate under the Act or tax treaty is lower than 20%, and the taxpayer has not furnished its PAN to the payer, the withholding tax rate of 20% will apply on the concerned payment. Exceptions from section 206AA are provided only in the following two scenarios:
1. Payment of interest on ‘long-term bonds’ referred to in section 194LC, or
2. Where the payee furnished certain information to the payer as prescribed in Rule 37BC (such as email id, contact number and address, tax residency certificate (TRC) of home country, tax identification number in home country, etc.)
As can be seen from the above, only the payment of interest on ‘long-term bonds’ referred to in section 194LC has been exempted from provisions of section 206AA of the Act [the term used for Masala Bonds is ‘rupee-denominated bonds’]. This exception provided by Finance Act, 2014 was a consequential amendment to section 206AA when payment of interest on ‘long-term bonds’ was granted benefit of section 194LC. The exception was mainly provided in line with overall intention to incentivise low cost long-term foreign borrowings by Indian companies.
Since the introduction of Masala Bonds in section 194LC by Finance Bill, 2017 also is to incentivise foreign borrowings by Indian corporates while mitigating the exchange fluctuation risk, it appears to be a bit surprising that exemption from section 206AA has not been extended to payment of interest on such bonds. As a result, it appears that all non-resident investors of Masala Bonds not having PAN in India, would necessarily have to comply with furnishing information under Rule 37BC to mitigate the higher withholding tax rate of 20% under section 206AA (which would otherwise defeat the purpose of introducing concessional withholding tax rate of 5%).
Consequences of complying with Rule 37BC
Complying with Rule 37BC could result in the following consequences:
– Investors having multiple investments in Masala Bonds, resulting in multiple interest payment dates in a year, could incur significant time and cost for compliance. For example, where TRC is issued by the home country as on date of application and not for the entire financial / fiscal year (for example, Luxembourg), an investor may need to obtain multiple TRCs for multiple interest payment dates.
– Once the non-resident investors comply with Rule 37BC, their details would be furnished by the Indian payer to the income-tax authorities in their withholding tax returns. Based on this, the possibility of the Indian tax authorities contacting these investors and asking them to file Indian tax returns cannot be ruled out. Such a step, if at all taken, could be contrary to the fact that investors earning income referred to in section 194LC on which entire tax has been deducted at source are not required to file tax returns as per section 115A(5).
– Compliance burden on the Indian issuers would increase as they would need to obtain these details from the non-resident investors and furnish them to the income-tax authorities. Any default on this part could result in proceedings being initiated on them for short-withholding of taxes, disallowance of expenditure, levy of interest / penalty, etc.
Our view
In our view, since the Indian Government has been actively focussing on increasing the ease of doing business in India, investors of Masala Bonds should also be extended the benefit of exemption from section 206AA as has been extended in the past to investors in ‘long-term bonds’.
