APRIL 24, 2020

By Vinod Yadav

INTEREST is an opportunity cost for the money lent over a particular period of time. It is a kind of a consideration that is usually generated upon an act of lending or deposit or advance of money. Albeit the parameters of supply as per GST law are encompassed inside the definitions of 'goods' and 'services', the taxability triggers upon the involvement of 'Consideration' and 'Furtherance of business'. A conjoint reading of the definition of 'goods' and 'services' as provided under Section 2(52) and 2(102) respectively of the CGST Act, 2017, reveals that a consideration in the form of interest is taxable under GST as it is neither specifically exempted nor merits exclusion from the definition of service.

One such transaction is issue of debentures where the interest income is generated on the purchase of debenture for a specified period of time. Debenture is obtained on the payment of money and earns interest thereon. On maturity, the debenture holder gets the refund of the money from the borrower.

The Companies Act, 2013 under Section 2(3) defines Debenture  as -

"debenture" includes  debenture  stock, bonds or any other instrument of a  company  evidencing a debt, whether constituting a charge on the assets of the  company  or not.

For the purpose of this article, debentures can be broadly categorized into convertible debentures and non-convertible debentures. Convertible Debentures carry an option of being converted into equity while no such facility is available in case of non-convertible debentures. Convertible debentures are further classified into Compulsory Convertible Debenture (CCD), which are mandatorily converted into equity on maturity. It is pertinent to mention that convertible debentures carry lesser rate of interest (ROI) as compared to non-convertible debentures.

Interest per se is taxable under GST. However, the Government vide Sr. No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28th June, 2017 has exempted interest income from the levy of GST. It grants unconditional exemption to interest earned on the services of lending having the below scope:

"Services by way of extending Deposits, Loans or Advances in so far as the consideration is represented by way of Interest or Discount (Other than interest involved in credit card services)".

The same notification defines "Interest" as -

"2(zk) "interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised;"

The exemption provided in the referred notification is not only wide but also vague and prone to different connotations. Broadly, it could be stated that in order to fit within the ambit of the exemption, the money must be extended as DEPOSITS, LOANS OR ADVANCES, and the consideration must be generated as an INTEREST.

As such, in order to avail the benefit of the given notification, it is very important to analyze the below terms and their relevance or nexus with the interest income generated on CCDs:

a. Loan

b. Consideration by way of Interest

a. Loan

The term 'Loan' is nowhere defined under the GST law. It is neither defined under the Companies Act nor under various other laws. Resultantly, we need to rely on the dictionary meaning which as per Free Dictionary is:

"In a loan of money, the money lent becomes the property of the borrower during the period of the loan against an undertaking to return a sum of equivalent amount either on demand or on a specified date or in accordance with an agreed schedule of repayments."

A Loan carries a precondition that the principal amount is needed to be repaid back to the lender. On the other hand, the amount of CCD is invariably converted into equity and is never repaid to the debenture holder. On this yardstick, it could be said that debenture is not exactly a loan.

The second differentiator is transferability. Unlike CCDs, a loan is not transferable as it is usually determined based on the credit score and list of available sources of income.

Thirdly, the consideration obtained on a loan is always interest and nothing else. But interest is not the sole consideration on purchase of a CCD. The other consideration is the cost of the obligation on the part of the issuer of debenture to convert such debentures into equity at future date.

Lastly, while there is no collateral involved for purchase of CCDs, a pure loan is usually disbursed against some collateral.

b. Consideration by way of interest

It appears that the intention of the legislature behind the grant of exemption was confined only up to the consideration which is exclusively in the form of interest alone. In other words, the exemption is extended only in those cases where the consideration is received as interest and only interest.

Interestingly, a CCD usually carries lower ROI than other loans. It demonstrates that the consideration is not exclusively interest but it is influenced by the advantage of conversion of the principal amount into equity on maturity as stated supra. To put it in other words, it could be said that the actual consideration is inclusive of interest plus agreed value for conversion of CCD into equity. Due to this obvious reason, it is not just an interest alone. Hence, it somewhere deviates from the intent of the statute.

As a corollary, it may be inferred that on both the aforementioned counts, the CCD appears to not satisfy the conditions of exemption stipulated under the mentioned notification and seems to be a taxable service under GST.

If we treat CCD as a "debt", then it stands a chance to fall under the exemption criteria of the given notification in contrast to "equity" which is totally out of its purview. Ironically, the arguments are available, both for and against, inasmuch as a CCD is to be treated whether as a debt or equity.

The FAQ released by the Government on Banking Sector has clarified -

Q.44 Is interest on debt instruments exempt from GST?

A. Yes. As debt instruments such as debentures, bonds etc. are in the nature of loans, interest thereon will be exempt from GST.

The Bangalore Income Tax Tribunal, in the matter of M/s CAE Flight Training India P Ltd Vs ITO, Bangalore (ITA No. 2006/Bang/2017), opined that CCDs cannot be characterized as equity.

Nonetheless, it is also relevant to mention that under Foreign Direct Investment (FDI) guidelines, for the purpose of reporting to the RBI, CCDs are considered as equity!

From the above standpoints, CCDs could be viewed as a hybrid of both - debt and equity.

In view of the foregoing discussion, it appears that availing exemption on interest earned out of CCDs would not be free from disputes. Inversely, paying GST on such interest amount may not be appropriate as it is not entirely free from the confines of the exemption criterion. It is not out of place to state that the amount of interest involved in such transaction is normally very high because many corporates/businesses purchase such CCDs in huge numbers.

As the matter seems to be ambiguous and subject to varied interpretations, it is imperative for the CBIC to come out with a clarification in the matter.

[The author is Lead-GST, Calderys India Refractories Limited, Sadar, Nagpur and the views expressed are strictly personal.]