NCD Redemption: Capital gain or interest income?

 

BACKGROUND

In terms of the provisions of the Companies Act, 2013, a debenture is defined to include inter alia “debenture stock, bonds or any other instrument of a company evidencing a debt[1] and is categorized into different types depending on their redemption tenure, convertibility, security, mode of redemption, type of interest rate, coupon rate, demonstrability, etc. One such type, which is most used commercially, is non-convertible debenture (NCD). NCDs are fixed-income instruments issued by companies / corporations. Unlike convertible debentures, NCDs cannot be converted into equity shares of the issuing company and have a fixed maturity date and bear coupon either on a recurring basis or at the time of redemption.

The issue surrounding the taxability of surplus derived from the redemption of debentures has been subject to considerable debate. However, the Hon’ble Income Tax Appellate Tribunal (Tribunal) has recently resolved this ambiguity vide its order in an appeal by Khushaal C. Thackersey (Assessee).[2] We outline below a snapshot of the Tribunal’s take on the taxability of differential sum between the proceeds received upon redemption of unlisted NCDs and its purchase cost.

BRIEF FACTS

In the year 2004-05, two companies undergoing corporate insolvency resolution proceeding, issued NCDs to banks against their outstanding loans amount under the rehabilitation scheme sanctioned by Board for Industrial and Financial Reconstruction. Post issuance, the banks pressed for payment of the NCDs. The Assessee, being one of the directors of the company, along with other individuals purchased the NCDs.

During the assessment year under consideration, the Assessee declared long-term capital gains on redemption of NCDs and invested the maturity proceeds in purchase of a flat under construction and also in REC bonds. Accordingly, the Assessee claimed the exemption under the capital gains head in terms of the provisions of the Income Tax Act, 1961 (IT Act).[3] However, the assessing officer rejected the claim of such exemption, aggrieved by which, the Assessee filed an appeal before the first appellate authority (FAA). The FAA rejected the appeal stating that the redemption of NCDs does not give rise to long term capital gains as claimed by the Assessee and the excess realized by the Assessee on redemption is to be assessed as interest income of the Assessee under the head of Income from Other Sources. Thereafter, the Assessee preferred an appeal against the order of the FAA in the Tribunal.

CONTENTIONS OF THE PARTIES

The Assessee contended that a debenture is a capital asset and redemption of such debenture thereof, would result in extinguishment of right and hence, proceeds out of such extinguishment would be covered by “capital gains” head. The Assessee also placed reliance on the case of Mrs. Perviz Wang Chuk Basi vs. JCIT[4], wherein the redemption of capital investment bond after maturity is held to be a “transfer” within meaning of Section 2(47) of the IT Act and accordingly, it was held that the same would give rise to Capital Gain or loss and similarly, the redemption of debentures would also result in extinguishment of rights in debentures.

On the other hand, the tax authority contended that NCDs are debt instruments and thus, if any debenture is redeemable at premium, such premium at redemption would be classified as an interest income. A reference was drawn to the circular issued by Central Board of Direct Taxes dated February 15, 2002, which essentially discusses the tax treatment of deep discount bonds wherein it states that any payment received on the maturity of the bonds must be treated as interest income.

TRIBUNAL’S RULING

The Tribunal following the reasoning of the tax authority, held that in any event of redemption, the NCDs are surrendered to the company and there is a realization of money advanced by the creditor and hence, no capital gains arise when the debentures are redeemed. The redemption of debentures is nothing but repayment of debt and the same cannot fall under the category of “extinguishment” as interpreted by the courts in the case of shares/preference shares. The Tribunal also observed that the premium received on redemption of debentures is nothing, but interest income and such income is assessable under the head “Income from Other sources”. Eliminating the ambiguities around this discourse, the ruling reiterates that capital gains can arise on transfer of NCDs before maturity, underscoring the importance for taxpayers to account for these factors when evaluating the tax treatment of their investments.

[1] Section 2(30) of the Companies Act, 2013.

[2] Khushaal C. Thackersey v. Assistant Commissioner of Income Tax [ITA 3679 Mum 2015].

[3] Sections 54F and 54EC of the Income Tax Act, 1961.

[4] (2006) (102 ITD 123).

DISCLAIMER

This material is for general information only and is not intended to provide legal advice. This material is distributed with the understanding that the authors are not rendering legal, accounting, or other professional advice or opinions on specific facts or matters and, accordingly, assume no liability whatsoever in connection with its use.

AUTHORS

Partner:

Rohan Kumar (Partner)
Shivansh Soni (Associate)

Associates:

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