How to create a robust debt market and facilitate bankruptcy-led acquisitions in a cost-efficient manner

Indian stock markets have been on a roll now for over four years, breaking one record after the other.

debt market, bad loans, bankruptcy law, GST, FDI liberalisation
These measures can help incoming buyers reduce potential tax leakages and allow banks to realise the maximum value resulting in lower hair cut in their debt.

By-Alok Mundra & Rashmi Shetty

Indian stock markets have been on a roll now for over four years, breaking one record after the other. Reform process is accelerated with the implementation of the goods & services tax (GST), FDI liberalisation process, and the Insolvency and Bankruptcy Code (IBC) to fix the prolonged debt problems in Indian banks and financial institutions, etc. As banks expect to maximise recoveries through resolution process under IBC, one expects Budget 2018-19 to provide certain incentives in terms of allowing business losses to be carried forward despite change in ownership, allowing the total book losses for minimum alternate tax (MAT) purposes, some changes in the deemed income section of income tax on account of purchase of shares, etc. These measures can help incoming buyers reduce potential tax leakages and allow banks to realise the maximum value resulting in lower hair cut in their debt.

Another area where the Reserve Bank of India (RBI) and the government can facilitate incoming buyers is by increasing the overall debt limits available for foreign portfolio investors (FPI). Over the last few years, non-convertible debentures (NCDs) have turned out to be one of the most popular methods of raising offshore debt and have been used extensively in acquisition of assets due to liquidity, lower cost of borrowing, rupee-denominated debt, no end-use or other restrictions, unlike external commercial borrowing, etc.

In September 2017, when debt limits exhausted the overall ceiling prescribed by RBI, RBI added approximately $7 billion limit, which was to be used over third and fourth quarters of FY18. However, considering overall demand, these limits are again close to the prescribed limits and, currently, debt limits are available through the auction process. Over the next few months, a good number of sizeable assets will be sold through the resolution process under IBC. In order to facilitate these transactions in an efficient manner, it would be worthwhile to reconsider these limits and increase them significantly.

In the context of NCDs, currently FPIs enjoy the benefit of concessional tax rate of 5% on interest payable before July 1, 2020, subject to prescribed conditions (otherwise taxed at 20% to FPIs). The said limit was initially set in 2015 and extended till 2017, and now till 2020. It has been observed in the past that the time limit for concessional tax rate is extended only at the time closer to its expiry. Currently, while the concessional tax rate is available till 2020, it would be worthwhile to reset this and extend it well in advance, which will provide certainty and clarity to long-term investors, and the cost of such funding can be factored appropriately in business plans.

In the case of performance-linked debt instruments, interest becomes payable only on fulfilment of certain performance-linked conditions. On the contrary, Income Computation and Disclosure Standards (ICDS)-IV provide that interest shall accrue with the passage of time and, therefore, an issue with respect to point of taxation (i.e. on payment or accrual basis) could lead to mismatch in terms of timing of taxation and withholding obligations. In this context, it is recommended that the disparity in recognition of interest income for tax purposes be clarified to avoid any litigations and align the same with the commercial understanding to facilitate such transactions.

In order to develop a healthy retail debt market, long-term capital gains exemption can be made available to listed bonds and debt instruments, as well as to bring them on a par with listed equity shares. This can enable the government to collect the Securities Transaction Tax (STT) and attract more investments in the bond market. Further, to bring parity between debt and equity, the holding period for reckoning long-term capital gains/loss for debt be aligned with that of equity shares—i.e. it should be reduced from 36 months to 24 months.

The aforementioned measures can go a long way in creating a robust debt market as well as facilitate bankruptcy-led acquisitions in a cost-efficient manner.

(Alok Mundra is partner and Rashmi Shetty is technical director, Deal Advisory, Tax and Private Equity, KPMG in India)

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