Indian corporations can raise foreign currency debt either by commercial loans from non-resident lenders through the external commercial borrowings (ECBs) route, or by issuing foreign currency convertible bonds (FCCBs), convertible into equity shares of the issuing company, for subscription by non-residents.
With a view to providing corporations with an additional window for overseas borrowing, the Reserve Bank of India (RBI) has put into operation a scheme for the issuance of foreign currency exchangeable bonds (FCEBs).
Issuing and subscribing
FCEBs are bonds expressed in foreign currency, the principal and interest in respect of which are also payable in foreign currency.
FCEBs may be issued by an Indian company (the issuing company) with the prior approval of the RBI, and may be subscribed to by a person resident outside India. FCEBs are exchangeable into equity shares of another Indian company (the offered company), either wholly or in part, or on the basis of any equity-related warrants attached to debt instruments.
The issuing company must belong to the promoter group of the offered company, and must hold the equity shares being offered at the time of issuing the FCEBs. The offered company must be a listed company engaged in a sector in which foreign direct investment (FDI) is permissible, and must be eligible to use ECBs or issue FCCBs.
If equity investment in the offered company would not qualify under the automatic route as per the foreign investment policy, entities subscribing to FCEBs are required to comply with the FDI policy and notified sectoral caps at the time of the issue. They must also obtain prior approval of the Foreign Investment Promotion Board.
The issuing company may invest the proceeds of FCEBs domestically in promoter group companies, which in turn are required to utilize such investments in compliance with end uses stipulated under the ECB policy. These purposes include:
(a) The import of capital goods;
(b) New projects, modernization or expansion of existing units in the real estate, industrial, infrastructure or notified service sectors;
(c) Direct investment in joint ventures or wholly owned subsidiaries abroad;
(d) First stage acquisition of shares in the government’s disinvestment process of public sector undertaking shares;
(e) Payments towards licences for 3G spectrum;
(f) Capacity building by NGOs engaged in micro-finance activities; and
(g) Premature buyback of FCCBs.
However, investment of FCEB proceeds in the domestic real estate sector or in capital markets is not permissible.
The proceeds of the FCEB issue may also be invested overseas by the issuing company as direct investment abroad, or in its joint venture or wholly owned subsidiary abroad, subject to compliance with extant guidelines governing such investments.
The issuing company or promoter group companies are required to retain the FCEB proceeds overseas in accordance with the ECB policy requirements.
Maturity and tax liability
A minimum maturity period of five years is prescribed. The holder of the FCEBs may exercise the exchange option at any time prior to redemption, taking delivery of the offered shares. Cash settlements of FCEBs are not permitted.
Prior to exercise of the exchange option on the FCEBs, the interest payments on the bonds are liable to deduction of tax at source as per the provisions of the Income Tax Act, 1961. Further, dividends on any exchanged portion of the FCEBs would be liable to tax in accordance with the act.
Exercise of the exchange option whereby the FCEBs are converted into equity shares will not be tantamount to a transfer under the act, and consequently will not give rise to capital gains liable to payment of income tax.
Further, transfers of FCEBs from one non-resident to another non-resident outside India will not attract income tax liability in India in respect of capital gains.
The FCEB scheme is likely to afford large Indian corporations greater flexibility to raise funds from overseas markets for new projects and acquisitions, enabling them to leverage their investments in group companies without diluting their shareholding.
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