A. INTRODUCTION:
COVID 19 has left all business to lose value artificially. Funding will be harder to get and down-rounds will be the new normal. Besides, valuations will be reset due to the increased macroeconomic risk. Promoters may lose control of the Company if the strategy of fundraising is not aligned with the market scenario. Indian promoters feel that owning close to half or more of the shares is the easiest way for them to retain control. They feel lower-share ownership may leave them open to the possibility of losing control to an outsider. This need for control is not unique to India or Indian promoters but is universal. No entrepreneur wants to work hard, create a firm, grow it and then lose control as soon as it becomes valuable.
B. GO PRIVATE DEBT/ STRUCTURED DEBT WAY:
Debt raise may be the right course of action for certain companies. In the current scenario, a straightforward debt raise has the attractive benefit of allowing you to retain ownership and control of your company. Convertible debt or a structured debt is essentially a mash-up of debt and equity where you borrow money from investors with the understanding that the loan will either be repaid or turned or underlined into a share in the company at some later point in time at certain benchmarked valuations. Private debt can be structured in the manner that is commercially best suited with a coupon that is payable annually, or a coupon that is paid only upon cash flows in the company, or any other trigger event.
In this article we have analysed the regulatory overview for raising debt in the Indian Private Limited Companies:
I. Fund Raising by way of debt by an Indian Company:
A private limited company may raise a loan in any of the manners as has been mentioned hereinbelow:
(a) Loan from Director:
A private company can accept money as loan from a person who, at the time of the receipt of the amount, was a director of such private company or a relative of the director of a private company. There is no restriction on the amount that can be borrowed from a director and/or relative of a director. However, in such cases, the following conditions shall be satisfied:
(i) The said person furnishes to the company, at the time of giving the money, a declaration in writing to the effect that the amount is not being given out of funds acquired by him by borrowing or accepting loans or deposits from others; and
(ii) the company shall disclose the details of money so accepted in the Board’s Report.
Such amount falls under the category of “exempted deposits” i.e. under Rule 2(1)(c)(viii) of Companies (Acceptance of Deposits) Rules, 2014.
The company shall file a return in e-Form DPT-3 (along with prescribed fees) at the time of acceptance of the loan and also on or before the 30th day of June, of every year with the Registrar of Companies and furnish the information contained therein as on 31st day of March of that financial year.
(b) Loan from members:
(i) A private company may accept a loan from its members not exceeding 100% of the aggregate of paid-up share capital, free reserves and securities premium account and the same shall be treated as deposits under CA, 2013. In this case, there is a restriction on the amount for acceptance of deposits by a private company from its members. The Board of Directors in its meeting shall take note of the borrowings made by the Company from its members.
(ii) There is no restriction on acceptance of deposits by a start-up company registered with DIPP for 5 years from the date of its incorporation. From the perspective of compliances, the same shall be noted by the Board of Directors in its meeting i.e. the same shall be part of agenda for the meeting and the necessary reference shall be given in the minutes of the meeting; and
(iii) A private company which satisfies all the following conditions; (a) such company is not an associate company or subsidiary company of any other company; (b) if the borrowings of such private company from banks or financial institutions or any body- corporate is less than twice of its paid-up share capital of Rs 50 crore, whichever is lower; and (c) such private company has not defaulted in the repayment of such borrowings subsisting at the time of accepting deposits, then there is no restriction on the amount for acceptance of funds by a private company from its members. From the perspective of compliance, the borrowing should be noted by the Board of Directors in its meeting of the directors.
(iv) The company shall file a return in e-Form DPT-3 (along with prescribed fees) at the time of acceptance of deposit and on or before the 30th day of June, of every year with the Registrar of Companies and furnish the information contained therein as on 31st day of March of that financial year.
(c) Loan from other companies:
Loan obtained by a private company from other body corporates is not considered as a deposit and the same can be obtained by passing appropriate board resolution under Section 179 of the CA, 2013. Further, the company shall file a return in e-Form DPT-3 (along with prescribed fees) at the time of acceptance of deposit and, on or before the 30th day of June, of every year with the Registrar of Companies and furnish the information contained therein as on 31st day of March of that financial year.
(d) Issuance of Compulsorily Convertible Debentures:
Issuance of compulsorily convertible debentures (“CCDs”) is governed by Section 71 of the CA, 2013. The Companies (Acceptance of Deposit) Rules, 2014 of the CA, 2013 lays down that CCDs should be converted into equity within a period of 10 years, or else, it shall be construed as a ‘deposit’ under the CA, 2013.
(e) Issuance of Non-convertible Debentures:
Non-convertible debentures (“NCDs”) are debt instruments which cannot be converted into equity shares of a company. Section 42 and 71 of the Companies Act, 2013 read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 and Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014 are the governing provisions for the issuance of secured unlisted NCDs by a private limited company to persons resident in India on a private placement basis. Issuance of NCDs by an eligible Indian company to an eligible non-resident shall come under the ambit of ECB Regulations and the same has been dealt with hereinbelow.
(f) Loan by a Start-up Company by the issuance of convertible notes:
Convertible Note is an option available to Indian startups that are looking for raising funds apart from directors, relatives or shareholders of the Company. Convertible Note is a new instrument for availing credit by an Indian Start-up. The terms of issuance of convertible notes to a foreign investor are laid down in Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”). ‘Convertible Note’ as defined under NDI Rules means an instrument issued by a startup company acknowledging receipt of money initially as debt, repayable at the option of the holder, or which is convertible into such number of equity shares of that company, within a period not exceeding five years from the date of issue of the convertible note, upon the occurrence of specified events as per other terms and conditions agreed and indicated in the instrument.
“Start-up company” under the CA, 2013 means a private company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognised as such in accordance with notification number G.S.R. 180I dated 17th February 2016 issued by the DIPP, Ministry of Commerce and Industry.
Therefore, a convertible note can only be issued by a start-up company recognised by DIPP. In accordance with the said notification, an entity shall be considered as a ‘startup’, subject to fulfilment of all the below conditions:
(a) Up to five years from the date of its incorporation/registration;
(b) If its turnover for any of the financial years has not exceeded Rs. 25 crores; and
(c) It is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.
An entity is considered to be working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property if it aims to develop and commercialize:
(a) A new product or service or process, or
(b) A significantly improved existing product or service or process, that will create or add value for customers or workflow.
Provided that the mere act of developing, (a) products or services or processes which do not have the potential for commercialization, or (b) undifferentiated products or services or processes, or (c) products or services or processes with no or limited incremental value for customers or workflow, would not be covered under this definition.
(g) External Commercial Borrowings (“ECB Route”):
The ECB Route is a highly regulated investment route. ECBs are commercial loans raised by eligible resident entities from recognised non-resident entities and should conform to parameters such as minimum maturity, permitted and non-permitted end-uses, maximum all-in-cost ceiling, etc. ECB can be raised in any freely convertible foreign currency (“FCY ECB”) as well as in Indian Rupees (“INR ECB”). Following is a brief framework of the ECB Regulations:
| Sl. No: | Parameters: | FCY denominated ECB: | INR denominated ECB: |
| 1. | Currency of borrowing: | Any freely convertible Foreign Currency | Indian Rupee (INR) |
| 2. | Forms of ECB: | Loans including bank loans; floating/ fixed rate notes/ bonds/ debentures (other than fully and compulsorily convertible instruments); Trade credits beyond 3 years; FCCBs; FCEBs and Financial Lease. | Loans including bank loans; floating/ fixed rate notes/bonds/ debentures/ preference shares (other than fully and compulsorily convertible instruments); Trade credits beyond 3 years; and Financial Lease. Also, plain vanilla Rupee denominated bonds issued overseas, which can be either placed privately or listed on exchanges as per host country regulations. |
| 3 | Eligible borrowers: | All entities eligible to receive FDI. | a) All entities eligible to raise FCY ECB; and b) Registered entities engaged in micro-finance activities. |
| 4 | Recognised lenders: | (a) The lender should be resident of FATF or IOSCO compliant country.
(b) Individuals as lenders can only be permitted if they are foreign equity holders (i.e. (a) minimum 25% direct equity holding in the borrowing entity, or (b) indirect equity holder with minimum indirect equity holding of 51%, or (c) group company with common overseas parent); or for subscription to bonds/debentures listed abroad and
(c) Foreign branches / subsidiaries of Indian banks are permitted as recognised lenders only for FCY ECB (except FCCBs and FCEBs). | |
| 5 | Minimum Average Maturity Period (MAMP): | MAMP for ECB will be 3 years. Call and put options, if any, shall not be exercisable prior to completion of minimum average maturity. However, for the specific categories mentioned below, the MAMP will be as prescribed therein:
(a) ECB raised by manufacturing companies up to USD 50 million or its equivalent per financial year, the MAMP is 1 year; (b) ECB raised from foreign equity holder for working capital purposes, general corporate purposes or for repayment of Rupee loans, the MAMP is 5 years; (c) ECB raised for (d) ECB raised for (e) ECB raised for ECB cannot be raised from foreign branches / subsidiaries of Indian banks for categories mentioned at (b) to (e). | |
| 6 | All-in-cost ceiling per annum: | Benchmark rate plus 450 bps spread. | |
| 7 | Other costs: | Prepayment charge/ Penal interest, if any, for default or breach of covenants, should not be more than 2 per cent over and above the contracted rate of interest on the outstanding principal amount and will be outside the all-in-cost ceiling. | |
| 8 | End-uses (Negative list): | The negative list, for which the ECB proceeds cannot be utilized, would include the following:
(a) Real estate activities; (b) Investment in capital market; (c) Equity investment; (d) Working capital purposes, except in case of ECB mentioned at 5(b) and 5(c) above; (e) General corporate purposes, except in case of ECB mentioned at 5(b) and 5(c) above; (f) Repayment of Rupee loans, except in case of ECB mentioned at 5(d) and 5(e) above; (g) On-lending to entities for the above activities, except in case of ECB raised by NBFCs as given at v(c), v(d) and v(e) above. | |
| 9 | Exchange rate: | Change of currency of FCY ECB into INR ECB can be at the exchange rate prevailing on the date of the agreement for such change between the parties concerned or at an exchange rate, which is less than the rate prevailing on the date of the agreement, if consented to by the ECB lender. | For conversion to Rupee, the exchange rate shall be the rate prevailing on the date of settlement. |
| 10 | Change of currency of borrowing: | Change of currency of ECB from one freely convertible foreign currency to any other freely convertible foreign currency as well as to INR is freely permitted. | Change of currency from INR to any freely convertible foreign currency is not permitted. |
Limit and leverage:
Under the aforesaid framework, all eligible borrowers can raise ECB up to USD 750 million or equivalent per financial year under the automatic route. Further, in the case of FCY denominated ECB raised from direct foreign equity holder, ECB liability-equity ratio for ECB raised under the automatic route cannot exceed 7:1. However, this ratio will not be applicable if the outstanding amount of all ECB, including the proposed one, is up to USD 5 million or its equivalent. Further, the borrowing entities will also be governed by the guidelines on debt-equity ratio, issued, if any, by the sectoral or prudential regulator concerned.
Procedure for raising ECB:
All ECB can be raised under the automatic route if they conform to the parameters prescribed under this framework. For approval route cases, the borrowers may approach the RBI with an application in the prescribed format (Form ECB) for examination through their AD Category I bank.
Obtainment of Loan Registration Number (LRN):
Any draw-down in respect of an ECB should happen only after obtaining the LRN from the RBI. To obtain the LRN, borrowers are required to submit duly filled in Form ECB, which also contains terms and conditions of the ECB, in duplicate to the designated AD Category I bank.
C. REPORTING REQUIREMENTS:
Monthly Reporting of Actual Transactions:
The borrowers are required to report actual ECB transactions through Form ECB 2 Return through the AD Category I bank on a monthly basis so as to reach Department of Statistics and Information Management, Reserve Bank of India within seven working days from the close of month to which it relates. If there is no transaction during a particular period, a ‘Nil Return’ should be submitted.
Quick Snapshot of considerations to be kept in mind for raising debt, based on the above analysis:
| Particulars: | Persons Resident in India: | Persons Resident Outside India: |
| Applicable Laws: | CA, 2013; and
Income Tax Act, 1961. | CA, 2013;
IT Act, 1961; and FEMA. |
| Interest Rates: | Regulated | Not Regulated |
| End Use: | Regulated | Not Regulated |
| Loan Registration Number from RBI: | Not Required | Required |
II. Taxability of Debt Instruments:
(a) In the event of the unsecured loan (other than NCDs) availed by the company from residents:
Tax implication on the Borrower:
Any company which is paying interest to a resident lender is required to deduct TDS within earlier of the following dates:
- At the time of credit of income to the payee’s account (i.e. accruing in the books of accounts of the borrower); or
- At the time of making payment to the lender.
The person who is paying interest is liable to deduct TDS on interest at the rate of 10%, however, if the PAN number has not been furnished by the lender, in that case, the deductor would be liable to deduct TDS at the rate of 20%. The deductor who has deducted TDS as per the said provisions is required to deposit the same within 7th of the next month (for the months of April to February). The TDS deducted in the month of March is to be deposited on or before 30th April. It may further be noted that TDS is not to be deducted when the aggregate amount of interest payable to a lender doesn’t exceed Rs. 5,000 in a financial year.
Tax Implication on the Lender:
The interest income received by any lender shall be taxed under the head ‘income from other sources’, however in the event that the lender is in the business of lending activities then the income would be taxed under the head ‘income from business and profession’.
(b) In the event of the unsecured loan (other than NCDs) availed by the company from persons resident outside India:
Tax implication on the Borrower:
Any company making payment to a non-resident (not being a company) or to the foreign company shall be liable to deduct TDS within earlier of the following dates:
- At the time of credit of income to the payee’s account (i.e. accruing in the books of accounts of the borrower); or
- At the time of making payment to the lender.
The person who is paying interest is liable to deduct TDS on interest at the rate of 20%. While calculating TDS rates we need to consider the provisions under DTAA for the relevant country if any. In case, payee fulfils all the conditions as prescribed in the DTAA, then rates as per DTAA will apply. Generally, rates under DTAA will be lower than normal TDS rates.
We have provided hereinbelow the rates of withholding tax in a few countries with which India has entered into Double Tax Avoidance Treaty:
| Particulars: | Mauritius: | Singapore: | Netherlands: | Cyprus: |
| Withholding tax on outbound interest: | 7.5% | 15% | 10% | 10% |
The deductor who has deducted TDS as per the said provisions is required to deposit the same within 7th of the next month (for the months of April to February). The TDS deducted in the month of March is to be deposited on or before 30th April.
Further, it may be noted that interest paid in respect of capital borrowed for the purpose of business or profession should be allowable as a deduction under Section 36(1)(iii) of the IT Act, subject to appropriate deduction of tax at source. Therefore, in order to claim a deduction of interest by a borrower, it is required that the funds raised by a borrower are utilized for the purpose of the business of the Company.
Thin Capitalization Norms:
In order to curb companies from enjoying excessive interest deductions and to keep a check on excess funding through debt, thin capitalisation norms were introduced in the year 2017. It refers to a situation where an entity has a high proportion of debt as compared to equity. These norms are applicable to an Indian company, who pays interest in respect of any form of debt issued to a non-resident or to a PE of a non-resident and who is an ‘Associated Enterprise’ of the borrower. Further, the debt shall also be deemed to be treated as issued by an Associated Enterprise where it provides an implicit or explicit guarantee to the lender or deposits a corresponding and matching amount of funds with the lender. In such a situation such interest shall not be deductible at the hands of the Indian company/ PE to the extent of the “excess interest”. The provisions restrict the payment of interest by an entity to its Associated Enterprise to the extent of 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to associated enterprise, whichever is less. The definition of associated enterprise is not limited to holding and subsidiary relationship. The meaning of associated enterprise, in essence, considers all such scenarios where an enterprise in substance is a) controlled, b) managed, c) policy-making and decisions are influenced either by way of voting power, control over the business, financial influence or control by another enterprise directly or indirectly. The detailed definition of associated enterprise has been laid down in Section 92A of the IT Act. Further, interest payments which are less than INR 10 million are exempted from the above requirement.
(c) In the event of issuance of NCDs by the company:
Tax implication of the Company issuing the NCDs:
The Borrower may structure the payment of interest on an NCD by way of redemption premium. The advantage of structuring the interest payment by way of redemption premium is that the interest payment needs to be accrued in the books of the borrower in each year and therefore, TDS is to be paid by the borrower to the Government on the interest so accrued in its books, irrespective of whether payment of such interest has been made or not. However, in case of redemption premium, it need not be accrued in the books every year and can be paid as a bullet payment at the time of redemption of debentures. Therefore, TDS is not payable every year and shall be payable only at the time of redemption of debentures.
Tax Implication on the allottee of the NCD:
The person to whom NCD is allotted is likely to earn income in the form of interest on NCDs or redemption premium in the event of redemption of NCDs. Interest earned on an NCD will be treated as ‘interest income’. These will be taxed at the same rate as any interest income and under the section ‘Income from other sources’ in the hands of the investor.
The taxation of any profits made either at the time of sale or redemption of debentures will vary depending on the period for which such debentures have been held. Generally, any profit on sale/redemption of unlisted debentures will become taxable as long-term if the same has been held for more than 36 months on the date of such sale/redemption. Thus, profits made on the sale of debentures shall be taxed as short term in case, they have been held for 36 months or less. However, in case the debentures are listed on any stock exchange in India, the qualifying period is 12 months instead of 36 months for it being treated as long term.
If the investor decides to sell the NCDs on the stock exchange before the NCD matures, there is a possibility of capital gains that can arise from such a sale. All short-term capital gains on the sale of NCDs are taxed at normal rates according to the taxpayer income tax slab. As for long term capital gains on listed securities, these are taxed at the rate of 10 per cent, plus applicable surcharge and cess, since debentures do not come with the indexation benefits.
Authors: Prashant Jain, Co-Founder & Partner; Anita Dugar, Senior Associate.
Disclaimer: The content of this article is intended to provide a general guide to the subject matter. For any queries, the authors can be reached at (i) prashant@samistilegal.in (ii) anitadugar@samistilegal.in.
Updated as on April 21, 2020.
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