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For Rupee-denominated bonds to take off, lower withholding tax needed
July, 03rd 2015

Tax treatment could well decide the fate of rupee-denominated offshore bonds, envisaged as a solution to the country's infrastructure funding needs.

The authorities are likely to levy just 5 per cent withholding tax in the final guidelines as anything higher than that could strangle the plan at birth, said four people familiar with the matter.

Such a move would allay investor apprehensions, said investment bankers who are already in talks with global investors.

Foreign currency bond issuances attract a 5 per cent withholding tax, deducted by Indian authorities before remitting the interest amount. This will be applicable till July 2017. Foreign institutional investors are also offered a concessional tax of 5 per cent on interest earned from government and corporate bond investments in the domestic market.

For Rupee-denominated bonds to take off, lower withholding tax needed

But the general practice is that overseas investors ask Indian issuers to price bonds after considering the tax factor. Therefore, higher tax leads to increased borrowing costs.

"A 5 per cent withholding tax will lead to higher cost of borrowing for issuers. Then we shall be better off by raising funds from the domestic corporate bond market," said an executive from a top state-owned company aiming to tap the fundraising route. The person did not want to be identified.

Rupee-denominated bonds are seen reducing funding costs by at least 150-200 basis points compared with domestic fund-raising avenues as the exchange-rate risk is shifted to buyers from sellers. A basis point is 0.01 percentage point.

About three years ago, the government reduced the withholding tax to 5 per cent from 20 per cent for overseas borrowings by corporates to tap international capital.

"This (rupee-denominated bonds) is a good window to tap long-terms funds, needed for India's infrastructure sector," said Shefali Goradia, partner, BMR Advisors. "The instrument should be encouraged with the maximum offer up to 12.81 per cent for raising 10-year money. According to market sources, both the central bank and the government are working actively on the final guidelines, which are expected in a month's time. "Higher tax burden will also make it expensive for domestic issuers who may have to pay higher coupon," said Vishal Shah, partner at PriceWaterhouseCoopers India. withholding tax at 5 per cent."

An issuer pegged at India's sovereign rating of BBB (negative) will need to offer an additional 150-180 bps if a 20 per cent levy is applied, dealers said.

The Reserve Bank of India issued draft guidelines a month earlier to sell rupee bonds offshore, setting a limit on the price at 500 basis points above that of government securities of similar maturity. This means a low-rated issuer may offer up to 12.81 per cent for raising 10-year money.

According to market sources, both the central bank and the government are working actively on the final guidelines, which are expected in a month's time.

"Higher tax burden will also make it expensive for domestic issuers who may have to pay higher coupon," said Vishal Shah, partner at PriceWaterhouseCoopers India.

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