A convertible debenture is an instrument where there is a change in the nature of the instrument after the completion of a specific period of time. Here the investment is initially a debenture usually which means that this has the nature of a debt instrument.
There are lots of times when investors buy convertible debentures. This gives rise to several questions with the main one being whether the transaction of the conversion will result in a transfer for the individual under the Income Tax Act and some tax liability will arise. This is a big worry due to the fact that the individual could end up with a tax burden in case they have not paid the required attention to the whole issue and a clarification is essential to ensure that there is no hidden surprise that could arise. Here is a closer look at the issue in detail. Convertible debentures A convertible debenture is an instrument where there is a change in the nature of the instrument after the completion of a specific period of time. Here the investment is initially a debenture usually which means that this has the nature of a debt instrument. There is a time period that has been mentioned at what point the conversion would take place and the investor would then hold equity shares in the company instead of the debentures that they held till then. This act of conversion is the act that is the cause of worry for a lot of people as the question is whether this a taxable event and whether tax incidence would arise at this stage since the entire instrument has changed. Not transfer If there are some specific conditions that are fulfilled then the conversion of the debt into equity shares would not be considered as a transfer and hence there would not be any question of a tax impact arising. The first is that the initial holding is in the form of bonds or debentures or debenture stock or deposit certificate in any company. This would include both an Indian company as well as a foreign company so the definition of company is quite wide on this front. The nature of the debt holding is also quite wide as it includes a lot of the different types of debt holdings that an individual would have and this is also a good sign. The second condition is that the capital asset is then converted to shares and when this happens this would not be counted as a transfer and for the investor it would be as if they have held the existing investment and there is no impact for them on the tax side. No preference shares There are clear directions as to what would be considered for the fulfilment of conditions under this rule and here there is a specific exclusion. Preference shares are to be clearly excluded from this working and hence if there are preference shares that are converted to equity shares then they would classify as a transfer and the tax implications would have to be worked out. The other debt options are not covered and this is a good thing as this would cover the normal workings that are witnessed in case of convertible debentures and similar such instruments. Lower tax impact The overall impact of this entire move is that there is a lower tax impact that comes about at the end of the day. Since this conversion is not to be considered as a sale for the purpose of capital gains then there is no tax incidence at this level and the question of taxation would come only at the time of the sale of the shares. If the shares are listed on the stock exchange and there is securities transaction tax paid on it and these are held for a period of more than one year then this would become long term capital gains tax. This would mean that the tax impact of this would become zero and this is a way in which the liability would come down.
There are lots of times when investors buy convertible debentures. This gives rise to several questions with the main one being whether the transaction of the conversion will result in a transfer for the individual under the Income Tax Act and some tax liability will arise. This is a big worry due to the fact that the individual could end up with a tax burden in case they have not paid the required attention to the whole issue and a clarification is essential to ensure that there is no hidden surprise that could arise. Here is a closer look at the issue in detail. Convertible debentures A convertible debenture is an instrument where there is a change in the nature of the instrument after the completion of a specific period of time. Here the investment is initially a debenture usually which means that this has the nature of a debt instrument. There is a time period that has been mentioned at what point the conversion would take place and the investor would then hold equity shares in the company instead of the debentures that they held till then. This act of conversion is the act that is the cause of worry for a lot of people as the question is whether this a taxable event and whether tax incidence would arise at this stage since the entire instrument has changed. Not transfer If there are some specific conditions that are fulfilled then the conversion of the debt into equity shares would not be considered as a transfer and hence there would not be any question of a tax impact arising. The first is that the initial holding is in the form of bonds or debentures or debenture stock or deposit certificate in any company. This would include both an Indian company as well as a foreign company so the definition of company is quite wide on this front. The nature of the debt holding is also quite wide as it includes a lot of the different types of debt holdings that an individual would have and this is also a good sign. The second condition is that the capital asset is then converted to shares and when this happens this would not be counted as a transfer and for the investor it would be as if they have held the existing investment and there is no impact for them on the tax side. No preference shares There are clear directions as to what would be considered for the fulfilment of conditions under this rule and here there is a specific exclusion. Preference shares are to be clearly excluded from this working and hence if there are preference shares that are converted to equity shares then they would classify as a transfer and the tax implications would have to be worked out. The other debt options are not covered and this is a good thing as this would cover the normal workings that are witnessed in case of convertible debentures and similar such instruments. Lower tax impact The overall impact of this entire move is that there is a lower tax impact that comes about at the end of the day. Since this conversion is not to be considered as a sale for the purpose of capital gains then there is no tax incidence at this level and the question of taxation would come only at the time of the sale of the shares. If the shares are listed on the stock exchange and there is securities transaction tax paid on it and these are held for a period of more than one year then this would become long term capital gains tax. This would mean that the tax impact of this would become zero and this is a way in which the liability would come down.
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