Traditionally, corporate securities were categorized into two either “stocks” or “debts”. This means that a transaction in the company’s security either created increased company’s assets or incurred a liability to the company. However, with a change in time where companies are entering a world of competition and complex business transactions, the need of ease of doing business lead to the invention of hybrid securities which combines characteristics of both debt and stocks. The invention of this new kind of security might seem ordinary at once, but problems would arise in determining the apparatus in which such securities would fall.  It becomes crucial to determine whether such securities are debts or stocks because the twain attracts separate tax treatment. If this conundrum is left unresolved then it would lead to a number of doubts in the minds of tax levying authorities as to how these securities should be taxed. Further, a concrete position on the nature of hybrid securities would also enable the holder of such securities in determining their position in a company.


Generally, corporate securities can be classified into stocks; representing shares and bonds; representing debts. A share is a right to a specified amount of share capital of a company [1] and entitles shareholders to have a voting right along with the right to interest and get return on investment upon existence of some profit. [2] This means that shares are risk-oriented instruments. Debt securities, on the other hand, are defined as non-convertible debt securities creating or acknowledging indebtedness of the corporate. [3] Debts don’t give any voting rights in management to debt holder and entitle the holder to payment of principal amount along with some interest at all events.

For incorporating benefits of both kinds of securities and for attracting investments, a new security called hybrid security comprising characteristics of both stock and bond has emerged. For having a clarity over hybrids, Supreme Court of India clearly laid down that the definition of securities under SCR is an inclusive definition and not exhaustive one. [4] The question as to whether hybrids should be considered as ‘securities’ is finally settled in the case of Sahara India Real Estate v SEBI [5] where the courts answered this question in affirmation by giving a wide interpretation to section 2 (h) of Securities Contracts (Regulation) Act, 1956. Identifying the nature of hybrid securities as debts or stocks is of relevance because to two main aspects: a) it clarifies the position of holder of such instruments in company; b) for commercial purpose because of differential tax treatment over dividends and interest.Indian jurisprudence has not flourished much over this issue and theories on categorizing hybrids into debts or securities is an arena which is yet to be exhausted by legal experts.

In this paper, I will be looking at various foreign judgments along with the various theories and approaches included in adjusting such matters. I would also look at how Indian Courts have dealt with various cases involving hybrid security instruments and then later come to a conclusion identifying the approach on which courts mostly rely on.

Approaches adopted by courts for determining nature of hybrid (U.S. Case Study)

Despite the absence of any cogent theory, the U.S. case law plays an important role as it continues to assess tax treatment of hybrid securities. The majoritarian view test that courts held is that of the ‘Facts and Circumstances’. The court in most cases have relied on the facts and circumstances surrounding the nature and appearance of hybrid securities. More weight to factors like intention of parties, presence or absence of a fixed maturity date for receiving principal amount invested, nature of interest attached to securities, right to vote or participate in management. The majority U.S. courts held the following tests for examining nature of hybrids: for determining parties’ intention, the court looked at the name of instrument [6], its position in taxpayer’s book [7]; absence of a fixed maturity date drove majority courts to interpret securities as debts; stable and enforceable interest payments made hybrid securities debts; voting rights triggered courts to classify hybrids as equities. Therefore the court gave more weight to the above mentioned subjective tests.

Share of a company entitles shareholders to certain rights, for instance, to access their right to vote in a manner they desire [8], right to enjoy dividend when declared in general meeting [9]. It is also established that in no circumstance, profit of the company cannot be treated as a debt due to shareholders; [10] whereas nature of debt is such that it has to be paid back along with definite rate of periodical interest after a fixed time irrespective of company’s profits. Therefore stocks and debts operates in two separate domains. Typically debt securities are non-convertible debt securities, so, categorizing hybrid securities like convertible bonds, compulsory convertible debentures, redeemable stocks, preferred stocks, equity default swaps etcunder the single roof of debt or stock would not be justified because such hybrids do not strictly conform the characteristics of either bonds or stocks but possess qualities of both kinds of securities.

It has been frequently observed that classification of hybrid securities into “all or nothing” framework on the basis of “facts and circumstance test” has often lead to differential results in similar facts. For instance, in Dorsey v. United States [11], preferred stocks which were issued in place of debt due to regulations were held equity while in Bowersock Mills & Power Co. v. Commissioner [12]preferred stocks issued in exchange of debts were held debt. Similarly, preferred stock having 7% cumulative payment with no fixed maturity date were held debts.[13]Therefore realizing the need for a middle land, the courts came up with “bifurcation approach” where securities are bifurcated into debt and equity components. The application of this approach could be traced in the cases of Farley Realty Corporation v. Commissioner [14] and Richmond, Fredericksburg & Potomac R.R. Co. v. Commissioner [15] where court bifurcated security into debt and equity components depending upon the interests that such security entailed. In the former case, there was a loan agreement between an individual and a corporation for the purchase of a building.The terms of the loan provided for repayment of principal amount after a fixed time along with some interest rate payments. It also provided for grant of 50% of the value of appreciation in property for which such loan was sought, which could happen either before or after the date of maturity of loan. This resulted in the court to interpret the loan agreement as both creating a debt and equity interest in the corporation as the right to get 50% interest was contingent in nature, involving risks of loss and thus formed an interest that a ‘stockholder’ has in any corporation. The latter case involved issuance of “guaranteed stocks” with dividend at the rate of 7% irrespective of the profits. The securities issued had no fixed maturity date but would become payable 6 months later in case of dividend default and had voting rights attached on the fulfillment of certain conditions. The court here bifurcated the stocks into debt (depending upon the fixed 7% interest) as well as stock (a contingency of voting rights depending upon fulfillment of certain conditions).

Even though bifurcation approach sounds appealing than the “all or nothing” approach, it might lead to practical difficulties as it would not always be possible to clearly separate debt and equity components of a hybrid security. In such cases, bifurcation would demand a percentage division of debt and equity components which would result in higher complexity and uncertainty in issuance of hybrid securities.

For determining the nature of hybrids, the courts also rely on the fact as to how these securities are represented in a corporate balance sheet or in article of association. Courts have interpreted that in situations where hybrids are demonstrated as stocks in balance sheet or AOA and holders of such securities have allowed the company to make such representation then such securities should be identified as stocks.[16] However this approach could be critiqued on the grounds that such treatment could cause serious prejudice at the time of liquidation process to those creditors who relied on such representation but instead find hybrid holders being treated at par with them. Further this would leave a larger discretion to the companies for determining status of hybrid securities and would result in diverse treatment of such securities. A possible solution proposed to this situation is that such hybrid holders at a lower pedestrian than such creditors who rely upon such representation.[17]Another problem could arise in cases where management of a company without consulting parties involved, alters the balance sheet and represents securities as stocks. A proposed suggestion to this situation is that in such scenarios, creditors should be treated at par with security holders and those creditors who relied upon this misrepresentation should be allowed to maintain personal proceedings against those individuals who made such misrepresentation.[18]

Treatment of Hybrid Securities in India

The use of hybrid securities as a mode of fundraising is quite prevalent in India as well. Therefore Indian Courts from time to time faced the need to identify certain hybrids as debts or stocks when any such matters were brought up.

In Narendra Kumar Maheshwari v. Union of India[19], the court held Compulsorily Convertible Debentures as ‘equity’ and not as a loan or a debt because such instrument does not involve any repayment of the principal and happens only in unlikely event of winding up of company. The question of security in such instruments become relevant for payment of interest. Therefore, unlike debenture, which is typically a debt, Compulsory Convertible Debentures are not paid back but are converted compulsorily into equity after lapse of a specified time.

Interim Analysis: It should be seen that Compulsory Convertible Debentures possess features of both debt and share. Debt component could be identified in the secured payment of interest on CCDs (like any other debt instrument, say debenture) and stock characteristic could be associated in treatment of such instruments as equity after a specified period, as well as repayment of principal amount only at the time of wind up. However, an analysis of Narendra Kumar case makes one interpret that court looked at the characteristics of CCDs in a broad sense and considered CCDs as equity because of absence of any obligation on company to repay the principal amount except in case of wind up (which is exactly the same manner in which shareholders are treated).

Optionally Fully Convertible Debentures (OFCDs), unlike Compulsory Convertible Debentures give an option to investor to either get back the principal amount back in cash or as equity shares and hence in such a way do not share the characteristic of more equity than of debentures as is seen in Compulsory Convertible Debentures.[20]

Interim Analysis: OFCDs held characteristics of both debt and stock securities. Holders of OFCDs enjoy periodical interests just like any other debenture holder. Further, it should be seen that in OFCDs, the repayment of principle is a postulate and is dependent upon the option of investor i.e. if the investor wants to get the principle amount back in cash or get it converted into equity. This means that the discretion given to holder of OFCDs could put an obligation on company to repay the principal amount just like any other debt instrument even if the company has not earned any profits. Therefore, an overall assessment of nature of OFCDs by courts outweighed the stock characteristics of OFCDs and made it to identify OFCDs as debts and not a security.

Preferred Stocks or Preference Shares are fixed income security instruments as they attach a fixed rate of dividend and have preferential treatment over equity shareholders in terms of payment of dividend and company’s assets in case of the windup. Payment of dividend on preference shares happens only when a resolution is passed by the company. Thus, it is sometimes seen that in cash flow difficulties situation, preferred dividend on preferred stocks may not be provided.

Interim Analysis: It should be noted that Preference Shares attach a fixed right to dividend like any other debt instrument which associates it to a characteristic of debt instruments, however such dividend is not secured because it could be paid only when company has incurred some profits.[21] Even thougha fixed income is attached to preferred stock (like debentures)and preference is given to them over an equity shareholder, the payment of a fixed dividend is not a guarantee. Therefore authors have interpreted preferred stocks as a share in ownership and not a debt to the company.[22]

While adjudicating upon the issue whether holder of Preferential Redeemable Preference Share (PRPS)is a creditor, Courts have held that holder of such shares does not automatically become a creditor and does not hold this position until the time of redemption of these shares at an appropriate time because such shares can be redeemed only out of profit of company.[23]Therefore PRPS according to Indian Courts are company’s stock and not debt because the limitation put on redemption of such shares is not applicable on any other creditor of the company.

Interim Analysis: PRPS are similar to debts in the sense that they, like any other debt, may create a charge on company at the time of redemption. However it should be noticed that such redemption is dependent upon company’s profits due to limitation put under second proviso of section 52(2) of Companies Act. This implies that PRPS like any other stock security have strong connection with profits of a company. Thus, the equity component of PRPS outweighs the debt component and hence courts treat PRPS as equity and not debts.


A close study of above illustrative examples can make us interpret that the courts in India do not follow the approach of bifurcating hybrid securities into debt and equity components but rather treats such securities in totality either as debt or stock of a company i.e. an “all or nothing” approach. In India, analysis of hybrid security within the contours of debt or security seems to be dependent upon facts and circumstances in which such securities operate. It could be said that more weight to facts like assured interest, irrevocable obligation to repay principal amount plays a major role in commenting upon the nature of hybrids. Further, a plain reading of recent case IDBI Trusteeship Services Limited v. Hubtown Ltd[24]gives us the indication that Court majorly rely on answering the question whether instrument guarantees assured return to investor or not. Therefore this clearly indicates that Indian courts still follow the facts and circumstances approach to a larger extent and do not prefer bifurcating components of a hybrid into debt and equity.


As we already know that there are both taxation and non-taxation reasons behind issuing hybrids, one could also suggest that for taxation purpose, bifurcation of securities should be allowed. However before relying on such approach, one should ascertain that debt and equity components are separable. In case the two are separable, debt and equity components should be treated separately but if this is not possible then one could rely on Emmerich’s test[25] and treat hybrid securities as equity. However the problem of identifying hybrids as equity in case of inseparable components would lead to a problem of associating rights of equity to those hybrid holders which closely resemble debts.

Therefore, I believe that the legislature should attempt to make a list of those hybrid securities which constitute security and which constitute debt. The legislature, in doing so, could list down the factors that would be taken into account while determining the nature of hybrids. Further a continuous update of this list should be done for catering new hybrid securities. Keeping in mind the increasing trend and need of hybrid securities, the legislature can also introduce a new legislation solely meant for issues related to hybrids.

 [1] Section 2 (84), Companies Act, 2013; Vodafone International Holdings v. Union of India, (2012) 6 SCC 613

[2] Section 43, Companies Act, 2013

[3] Section 2 (1)(c) SEBI Act

[4]SudhirShantilal Mehta V. Central Bureau of Investigation, (2009) 8 SCC 1

[5] (2013) 1 SCC 1

[6]Bowersock Mills & Power Co. v. Commissioner, 172 F.2d 904 (10th Cir 1949)

[7] United States v. South Georgia Railway Co., 107 F. 2D (5th Cir. 1939)

[8]Vodafone International Holdings v. Union of India, (2012) 6 SCC 613

[9] Calcutta Tramways Co. Ltd v. CWT, (1973) 3 SCC 35

[10] Ibid 4

[11]311 F. Supp. 625 (S.D. Fla. 1969)

[12] 172 F.2d 904 (10th Cir. 1949)

[13] United States v. Title Guarantee Trust & Company, 133 F. 2D 990

[14] 279 F.2d 701 (2d Cir. 1960)

[15]4 F.3d 244 (4th Cir. 1993)

[16] Booth v. Union Fibre Co., 142 Minn. 127, 171 N. W. 307 (1919); Armstrong v. Union Trust & Savings Bank, 248 Fed. 268 (C. C. A. 9th, 1918)

[17]Status of Holders of Hybrid Securities: Stockholders or Creditors? (1936) 45, pp 915-916, The Yale Law Journal Company Inc<http://www.jstor.org/stable/792114> Accessed on 29/04/2018

[18]Ibid 17

[19] AIR 1989 SC 2138

[20] Sahara India Real Estate Corporation Ltd. v. SEBI, (2013) 1 SCC 1

[21] Section 123, Companies Act, 2013

[22]https://www.researchgate.net/profile/Jaan_Alver/publication/24137741_Preferred_Stock_Liability_or_Equity/links/57f90d9508ae8da3ce5a0f13/Preferred-Stock-Liability-or-Equity.pdf?origin=publication_detail, <Accessed on 3/5/2018>

[23] Aditya Prakash Entertainment Pvt. Ltd. v. Magikwand Media Pvt. Ltd., 2018 SCC Bom 551; Hindustan Gas and Industries Ltd. v. Commissioner of Income Tax, West Bengal II,  1978 SCC Cal 410

[24] (2017) 1 SCC 568

[25] Adam 0 Emmerich “Hybrid Instruments and the Debt-Equity Distinction in Corporate Taxation” (1985) 52 University of Chicago Law Review <https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?referer=https://www.google.co.in/&httpsredir=1&article=4389&context=uclrev >Accessed on 05/05/2018

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Qualification: Post Graduate
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Location: Delhi, Uttar Pradesh, India
Member Since: 04 Dec 2018 | Total Posts: 3
Tanya is an Indian qualified lawyer. She graduated from Jindal Global Law School and holds an LL.M. in IPR from Amity Law School Noida. View Full Profile

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