NEW DELHI: A Delhi High Court ruling on gains from compulsorily convertible debentures along with a slew of measures announced in the budget to spur the real estate sector are likely to encourage foreign private equity funds to invest in the country's real estate market, experts say.
The Delhi High Court had last week held that gains arising in the hands of a foreign company or funds from sale of compulsorily convertible debentures (CCDs) of an Indian company should be characterised as capital gains and not interest income.
Securities held for at least 12 months prior to transfer are treated as longterm capital asset in India and their sale attracts nil tax.
The court was hearing a petition by Zaheer Mauritius, a Goldman Sachs entity, which had in 2007 subscribed to CCDs issued by a joint venture company of Gurgaon based builder Vatika. In 2010, Zaheer Mauritius sold the CCDs back to the builder, expecting the gains to be treated as long-term capital gains and, thus, not liable for no tax deduction.
This was, however, challenged by the income tax department, which considered the gains as 'interest income' and demanded tax at the rate of 20% (plus surcharge and cess) on the transaction. The income tax department's argument was upheld by the quasi-judicial Authority for Advance Ruling (AAR).
"There has been uncertainty on treatment of CCDs as quasi equity versus debt or loan," said Sunil Jain, partner at law firm J Sagar Associates.
"This (high court) ruling provides clarity regarding capital gains treatment for the upside on CCDs as against disadvantageous classification as interest." Ruchir Sinha, head private debt and co-head private equity at law firm Nishith Desai Associates, said it would be very harsh to say that any amount of upside one earns on debentures will be seen as interest.
"If debentures are also capital assets in the books of the investor, then the gain on it should be capital gains. For something to be qualified as interest, the payer should be entitled to deduction as well," he said.
Over the last few years, investors putting in money in Indian real estate were concerned about both regulatory and market issues. While the real estate industry was facing a downturn with home sales at a low and corporate office leasing in slow mode, on the regulatory side, investors were apprehensive about issues around treatment of CCDs, put and call options and the jurisdiction of Mauritius as an investment route.
The high court order allays many of these fears. "People had a fear about how the income tax department would look at such transactions that involve CCDs. This order gives out a message that Indian laws are clear, there is no ambiguity about them," said Sunil Rohokale, managing director of ASK group.
In recent years, foreign money into Indian real estate was coming mainly through the listed non-convertible debentures (NCDs) route. "Now it will also come in through the unlisted CCD/quasi equity route," said Anckur Srivasttava, chairman of Gen-Real Property Advisers. With a stable government at the Centre, sentiments of both investors and consumers have improved in the last two months.
What has also helped change investor sentiments is a slew of measures by the new government aimed at improving the health of the Indian real estate sector. In his maiden budget, finance minister Arun Jaitley announced a reduction in the size of real estate projects eligible for FDI to 20,000 sq metres from 50,000 sq metres and halved the threshold limit for FDI to $5 million (about Rs30.5 crore).
"The recent trends in the asset-backed securities and commercial mortgage backed security (CMBS) space on the back of the budget statement by the finance minister to allow pension funds to invest in these instruments will create an enabling and positive environment," said Srivasttava.