Spicing up masala bonds to attract investors

Amit SinghaniaShardul Amarchand Mangaldas & CoMasala bonds have offered much needed relief to India Inc seeking foreign debt for their businesses. Being rupee-denominated, masala bonds offer India Inc the unique advantage of not being subject to foreign exchange fluctuation risks. Besides, it also offers material access to international markets by providing a deeper investor base to India Inc, which was hitherto solely dependent either on the Indian bond market or expensive sources of foreign debt financing. However, the uncertainty surrounding the tax rate applicable to such bonds continues to shadow their attractiveness to the foreign lenders.At present, there is a complex web of tax provisions that one must charter through before determining the applicable tax rate on foreign debt. The tax rate is at present a function of the status of the foreign tax payer (whether FII, QFI or ordinary foreign company), currency of debt, purpose of debt, etc. The tax rate on foreign debt ranges from 5 to 40 percent under the domestic law.Rupee-denominated bonds have presently been offered a beneficial 5 percent tax withholding rate only in respect of interest payments made to FIIs and QFIs before July 1. Pursuant to such date, domestic tax law will tax rupee-denominated bonds at 40 percent in case of foreign companies (other than FIIs) and at 20 percent in case of FIIs. To bolster India Inc to benefit from rupee-denominated offshore lending, the government should consider extending the July 1 sunset date.In 2015, the Central Board of Direct Taxes had indicated that the 5 percent tax rate would be extended to Masala Bonds for all categories of investors. In its press release, CBDT mentioned that capital gains arising in case of appreciation of rupee between the date of issue and the date of redemption against the foreign currency in which the investment is made would be exempted from capital gains tax. However, there has been no legislative measure thus far to implement such a press release. This has created an ambiguity surrounding the tax rate applicable to masala bonds for investors other than FIIs/ QFIs. While an amendment incorporating the spirit of the press release did not find place in the Finance Bill 2016, appropriate amendments are expected in Budget 2017 to close the loop on the taxation of masala bonds.Masala Bonds are still a nascent debt instrument in global capital markets. While India Inc. fishes to become a popular investment destination, spicing up Masala Bonds by bringing tax clarity and extension of sunset dates might just be the right recipe for attracting the taste buds of investors in foreign financial markets.Author is Amit Singhania, Partner, Tax and Gouri Puri, Principal Associate, Shardul Amarchand Mangaldas & Co.