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ITAT: Redemption of unlisted NCDs will not result in cap gains, but interest income

Mumbai, May 7, 2024

The Mumbai bench of the Income-tax Appellate Tribunal (ITAT) has recently held that the differential sum between the proceeds received on redemption of unlisted non-convertible debentures (NCDs) and its purchase cost, will be treated as ‘Interest income’ and taxed under the head ‘Income from other sources’, in the hands of the investor. Thus, the ITAT also denied the tax sops available for investment of long-term capital gains related proceeds in specified assets.

Under a corporate insolvency resolution process, two private companies issued NCDs to banks against their outstanding loans. The issue was under the rehabilitation scheme sanctioned by the Board for Industrial and Financial Reconstruction. Later, the bankers pressed for recovery of the NCDs from the directors of the companies.

KC Thackersey, who was one of the directors purchased the NCDs from the nationalized banks. During the financial year 2009-10, he declared long-term capital gains on redemption of these NCDs. The Income-tax (I-T) Act provides for tax benefits if on earning long-term capital gains, the proceeds are invested in a house property or capital gains bonds. As Thackersey had made such investments, he claimed a deduction under sections 54F and 54EC respectively. However, the Mumbai ITAT denied these deductions as it had held the surplus received by him on redemption to be interest income and not capital gains.

Chartered accountants state that taxpayers should upfront know the tax implications of the instruments they invest in to avoid unpleasant surprises later. According to Hinesh R. Doshi, chartered accountant, “In the case of zero-coupon bonds or deep discount bonds – most of which are listed securities, the issuer company does not pay any interest or coupon during its tenure, thus all income earned is in the form of capital gain at the time of redemption. In the matter decided by the ITAT, the NCDs were unlisted – the core character of such debt instruments is to earn interest income. The matter relates to substance over form and the conditions of the NCD offer letter tilts towards interest income and not capital gains.”

Amarpal Singh-Chadha, tax partner and India mobility leader at EY-India, adds that: This ITAT order clarifies the redemption of debenture is a realization of debt and not an extinguishment of rights. Further, the premium payable on redemption of debenture is in the nature of interest income. The order also clarifies that capital gains can arise on such instruments if they are transferred to third party prior to maturity. Taxpayers need to consider such distinction while determining the tax treatment.”

[The Times of India]

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