The Centre has now said that the tax treatment spelt out for exchangeable bonds in the FCEB scheme would be legally valid for the purpose of the income tax law. This would imply that the tax department cannot question the legal validity of the tax treatment on such bonds as spelt out in the FCEB scheme 2008.

Official sources said that the tax treatment would be applicable from assessment year 2008-09 and subsequent years. As per the tax treatment spelt out in the FCEB scheme, interest paid on such bonds would attract tax deduction at source (TDS) until the exchange option is exercised.

Moreover, dividend on exchanged portion of the bond would also attract tax as specified under Section 115 AC (1), which is the provision dealing with tax on income from bonds purchased in foreign currency.

The FCEB scheme also specifies that exchange of such bonds into shares would not give rise to any capital gains that would be liable to income tax in India.

Similarly, FCEBs transferred outside India by an investor who is resident outside India to another investor resident outside India would not give rise to capital gains liable to tax in India.

The FCEB scheme, announced in mid-February, seeks to help Indian promoters raise money abroad by issuing foreign currency bonds against the value of their investments in shares of listed group companies.

The bonds are described as exchangeable bonds as investors abroad could exchange them into equity shares or warrants of the listed group company before their redemption.