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Capital gains tax waiver likely for bond, debenture holders
March, 21st 2016

In a significant boost to financial instruments such as convertible debentures, the government has clarified the tax provisions relating to them, addressing lacunae that had discouraged companies from using them to raise capital.

The government will treat bonds and debentures as a single security for calculating the holding period without factoring in the conversion date, a decision that could make investors eligible for long-term capital gains tax exemption. Thus, the holding period for the long-term capital gains tax will be from the date a debenture or bond is acquired and not from the day the debenture is converted to shares.

The government will treat it as a single security for calculating the holding period even after conversion. The Central Board of Direct Taxes, the apex direct taxes body, has amended the rules dealing with the issue. The new regime will come into effect from April 1.

There had been lack of clarity on the date from which the holding period is to be calculated if an instrument such as convertible debentures is converted to shares as the law did not provide for it. The ambiguity in law led to litigation since tax authorities tend to take the stand that the date of conversion is the date of acquisition, thereby denying investors the benefit of holding that investment from much earlier and imposing higher tax liability.

These instruments are commonly used by the industry, particularly to raise foreign capital and in merger and acquisition deals. Foreign investors raised this issue time and again in their representations. The Punjab and Haryana High Court recently said the date of acquisition of shares acquired on conversion is the date of acquisition of debenture and not when it is converted.

Tax authorities, especially at lower levels, however continued to take the opposing view. The Narendra Modi-led NDA government, which promised a stable, predictable and non-adversarial tax administration after taking charge in May 2014, has attempted to simplify, rationalise and clarify a number of issues that irked foreign investors or fuelled litigation.

The latest amendment is in line with this objective and comes close on the heels of a clarification regarding tax treatment of consortia for infrastructure projects. The Budget for 2016-17 presented last month unveiled a number of steps for simplification of both direct and indirect taxes.

Rakesh Nangia, managing partner at tax advisory firm Nangia & Co said, "In the recent past we have seen that India is moving towards tax clarity and simplicity at a fast pace. Predictability and certainty in tax laws infuses the much-needed confidence in the taxpayers, both domestic and foreign, and shall have a ripple effect on the growth of Indian economy as a whole."

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