Private Credit: Interest on NCDs recharacterized as dividends 

The income tax department has held that interest income derived from non-convertible debentures (NCDs) was ‘fictious’ in nature and had not been appropriately offered to tax. In its reassessment order dated 29th March 2022, the Revenue claimed that the interest income was, in fact, a dividend.

 

The recharacterization of interest into dividends by tax authorities poses significant concerns for offshore debt investors as well as investee companies and shows the aggression with which the tax authorities are re-looking at structures.

 

In this Analysis, we discuss the tax authorities’ reassessment order recharacterizing the interest earned on NCDs and set out a few mitigants that private credit players can consider while structuring debt instruments to avoid such recharacterization.

Key Takeaways:
  • Tax authorities recharacterized interest income on NCDs as dividends
  • Interest recharacterization has not taken place under GAAR
  • Investors can prevent such mischaracterization by demonstrating the nature of the underlying instrument, periodicity of payments, maturity date, management rights, etc.

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