Interest on EBs to carry withholding tax burden

NEW DELHI: Exchangeable bonds (EB) will have to carry the burden of withholding tax on interest payments to bond holders. EBs, a much-awaited financial instrument, will allow corporates to raise foreign funds against their holding in group companies.

A company issuing EBs will have to deduct withholding tax from all interest payments it makes to subscribers. EB is a quasi-debt instrument that will allow large corporate houses with multiple subsidiaries to raise money without actually selling shares. This is how it works: Say, an industrial group ABC with a subsidiary X wants to raise money.

ABC can issue bonds which, on redemption, would be convertible into shares of X. As a result, ABC will be able to raise resources and enjoy dividends as well as voting rights on these shares till the bond matures.

The interest payments the company makes to its bond holders will be subject to a deduction of withholding tax (TDS) at the rate of 10%. However, when the bond is converted into equity, it would not attract any capital gains tax in India. But a bond holder may have to pay capital gains as per the rules of his country of residence.

“The guidelines for EB schemes have been finalised. The clarifications from the tax department have come as well. The guidelines will now be sent to the law ministry,” a government source said, adding the draft would be placed in the public domain to elicit comments.

He said the guidelines for the scheme would be similar to those for foreign currency convertible bonds. Though similar to FCCBs, EBs are different in that these would be redeemed for shares of a group company in which the issuing company has a stake. FCCBs, in contrast, can be redeemed only for shares of the issuing company. The scheme was announced by finance minister P Chidambaram in the Budget.