Top 5 Tax Considerations When Structuring Debt Investments in India

As distinctions between debt and equity are collapsing, investors may face challenges when interpreting applicable tax rules when investing into structured debt instruments.

 

Different regimes have adopted varied approaches when classifying convertible instruments as either debt or equity. Tax authorities are increasingly resorting to the usage of GAAR to reclassify the nature of income based on an assessment of the underlying substance. Transfer pricing rules, beneficial ownership rules, and thin capitalization rules, implemented as tax-avoidance measures in recent years, have similarly disrupted conventional structuring efforts.

Key Takeaways:
  • Recent developments in the Indian tax regime have brought India closer to global norms though hybrid instruments that have come under increased scrutiny
  • GAAR provisions have enabled tax authorities to examine the commercial substance of transactions, underscoring the importance of purpose, pooling, and people
  • Hybrid debt instruments face varied treatment under DTAAs vis-à-vis capital gains which may result in challenges when claiming treaty benefits
  • Beneficial ownership rules in DTAAs restrict treaty benefits to the entity exercising actual control over a return/income received
  • Is redemption premium interest income or capital gains? While DTAAs say interest, courts in India say capital gains. Conflicting classifications should not be a concern