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India: Ruling on characterisation of surplus on sale of debentures



Rajendra Nayak

Aastha Jain

The Delhi High Court (HC) in a recent case of Zaheer Mauritius [WP(C) 1648/2013 & CM No. 3105/2013], ruled on whether gains arising on sale of Compulsory Convertible Debentures (CCD) can be regarded as interest under the Indian Tax Laws (ITL) as well as under the India-Mauritius tax treaty (the Treaty). Zaheer Mauritius (Taxpayer) was a Mauritius company, which invested in 35% equity holding of a joint venture Indian company (JV Co) which was a subsidiary of another Indian company (JV Partner). Taxpayer also had invested in CCDs of JV Co. These investments were held as capital asset by Taxpayer. A shareholder's agreement was entered between JV Partner and Taxpayer, providing for a call and put option in relation to investment made by Taxpayer in JV Co. It was agreed that the purchase price of the CCDs would depend on the period of holding and an internal rate of return. Consequently, JV Partner purchased certain shares and entire CCDs held by Taxpayer in JV Co by exercising the call option, which resulted in surplus to the Taxpayer.

On an application, the Authority for Advance Rulings (AAR) ruled that gains arising on sale of CCDs is in the nature of interest under the ITL as well as under the Treaty, on the basis that JV Co and JV Partner are one and the same entity. Further, the transaction designed as purchase of CCD is a sham and it is in effect interest payments made by JV Partner in the capacity of a debtor to Taxpayer. Aggrieved, Taxpayer filed a Petition with the HC.

The HC stated that merely because an investment agreement provides for exit options to an investor by assuring a minimum return, it would not change the nature of the investment made. The transaction involving CCDs and understanding between Taxpayer and JV Co represented a genuine commercial venture and there was no reason to ignore the legal nature of CCDs or to lift the corporate veil to treat the underlying JV Co and JV partner as a single entity thereby meriting characterisation of part of the transfer price as interest. Characterisation of the surplus on sale of CCDs as capital gains depends entirely on whether the debentures are capital assets in the hands of its holder, irrespective of whether the investment in CCD is a loan arrangement or is in the nature of equity. As Taxpayer held the CCDs in JV Co as capital asset, the HC decided that gains arising from transfer of such CCDs would be capital gains, not taxable in India by virtue of the Treaty.

This HC decision reiterates the principles laid by the Indian Supreme Court in the case of Vodafone International Holdings BV [6 SCC 613 (2012)], wherein it was held that the transaction as a whole must be looked at and one cannot start with a presumption that the transaction is a tax saving device.

Rajendra Nayak ( and Aastha Jain (


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