CCD capital gain- Investors from Mauritius, Singapore, Cyprus face tax claim

  • August 9, 2023
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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CCD capital gain- Investors from Mauritius, Singapore, Cyprus face tax claim

Subject :Economy

Section: Capital Market

In News: Foreign investors from Mauritius, Cyprus and Singapore have been on the receiving notices for gains from investment in fully or compulsorily convertible debentures (CCDs) issued by Indian companies.

Key Points: 

  • CCDs, which are compulsorily converted into equity after a specified period, became popular after the tax treaties of these regions with India were amended in 2017, with the aim of taxing capital gains on shares in India.
  • Government view:
    • The tax authorities believe that capital gains accruing or arising to a tax resident is now taxable in India irrespective of the nature of instruments that are being sold.
    • FDI guidelines treat CCDs as equity for the purposes of reporting to the Reserve Bank of India. However, they are treated as debt for the purpose of income tax till the time of conversion.
  • Foreign investor view:
    • Foreign investors believe that the sale of securities other than shares continue to remain non-taxable.
    • As CCD are debt instruments, there is no capital gains tax to be paid in India by, say, a Mauritius investor subscribing to CCDs of an Indian company.
    • Investors in CCDs are legitimately using these instruments for earning interest income and do not have the rights enjoyed by an equity holder until converted
  • What does the treaty say?
    • The treaties, post amendment, made capital gains on “shares” taxable in India. However, the amendments do not apply to debt instruments.
    • Debt instruments still fall under the residual clause in the tax treaties, according to which the gains on such instruments will be taxable only where the resident is based.
  • What do the Authority for Advance Ruling (AAR) and High court say?
    • The Authority for Advance Ruling had ruled that the gains arising on sales of equity shares and CCDs were taxable as interest income.
    • The HC, however, held that these gains should be treated as capital gains.
  • What may be the solution?
    • Tax department can decide to treat CCDs as shares because the RBI treats these instruments at par with equity.
    • Alternatively authorities may apply GAAR to these transactions.
Compulsorily Convertible Debentures (CCDs)

  • Compulsorily Convertible Debentures (CCDs) are a type of financial instrument issued by companies to raise capital from investors. They are a hybrid security that combines the features of debentures and equity shares.
  • The term “Compulsorily Convertible” implies that these debentures must be converted into equity shares of the company after a specified period or when certain conditions are met.
  • The conversion price is the predetermined price at which each CCD will be converted into equity shares. The conversion ratio determines how many equity shares will be issued for each CCD. These terms are set at the time of issuing the CCDs.

General Anti-Avoidance Rules

  • GAAR stands for General Anti-Avoidance Rules, and it refers to a set of rules and regulations aimed at preventing tax avoidance practices by businesses and individuals.
  • In India, GAAR was introduced to counter aggressive tax planning that goes against the intent of the tax laws. It became effective in India from 1 April 2017, almost eight years after it was first introduced in the then proposed Direct Taxes Code Bill (DTC), 2009.
  • The main objective of GAAR is to target transactions and arrangements that are not driven by legitimate business purposes but are primarily designed to gain tax benefits. GAAR applies to any arrangement that’s considered an ‘impermissible avoidance arrangement.’
  • If GAAR is invoked, the tax authorities have the power to ignore the arrangement for tax purposes, and levy taxes as if the arrangement hadn’t been made. The tax benefits that the taxpayer attempted to gain through the arrangement can be denied.
  • The law also includes a ‘Principal Purpose Test’ (PPT), which ensures that GAAR is invoked only if one of the main purposes of an arrangement is to obtain tax benefits. If a taxpayer can prove that the arrangement wasn’t entered into primarily for tax benefits, GAAR may not apply.
  • The introduction of GAAR has led to increased transparency in tax planning and has prompted businesses to ensure their transactions have legitimate business purposes beyond just tax benefits.

Authority for Advance Rulings (AAR)

  • The Authority for Advance Rulings (AAR) is a quasi-judicial body established under the Income Tax Act, 1961 in India. It serves as a mechanism for taxpayers to seek clarification and guidance on the interpretation of tax laws and their potential tax liabilities before undertaking certain transactions.
  • AAR is composed of retired judges of the Supreme Court of India or retired Chief Justices of High Courts, along with members from the Indian Revenue Service (IRS). The members must have experience in taxation and law.
  • AAR’s jurisdiction extends to non-resident taxpayers, including foreign companies, and Indian residents who have transactions with non-residents. It covers various aspects of direct taxation, such as income tax, capital gains tax, and tax residency.
  • While the AAR’s ruling is binding, it can be challenged through an appeal in the High Court if either the taxpayer or the tax department disagrees with the ruling. However, the ruling remains in effect until the appeal is resolved.
CCD capital gain- Investors from Mauritius economy