COMPANY LAW ROADBLOCK HITS TAX-FREE BONDS

Thursday, 27 December 2012 9:14 PM

COMPANY LAW ROADBLOCK HITS TAX-FREE BONDS Many companies earlier planning to buy tax-free bonds are staying away for fear of breaching a company law provision. Investments of up to Rs 5,000 crore are likely to be affected, as up to 10 per cent of bond public issues are reserved for corporate subscribers. In addition, issuers had planned to raise funds through private placements for big-ticket corporate and institutional investors. Top state-owned infrastructure companies such as Rural Electrification Corp,Power Finance Corp, IIFCL, Hudco, NHAI, NHB and IRFC plan to raise at least Rs 50,000 crore in all, by issuing long-term infrastructure bonds by March. Interest income on these bonds, designed to encourage long- term investment in infrastructure and announced by the finance minister in his budget speech, are exempt from tax. The provision in the Companies Act relating to inter-corporate deposits and a recent Reserve Bank of India ( RBI) circular on the bank rate that helps interpretation of this provision have queered the pitch for public sector infrastructure firms raising money through issue of tax-free bonds, said bankers. Section 372A(3) of the Companies Act says, "No loan to any body corporate shall be made at a rate of interest lower than the prevailing bank rate, being the standard rate made public under section 49 of the Reserve Bank of India Act, 1934." The bank rate was untouched at six per cent since 2003. In February, RBI as a `one-time technical adjustment' decided to align the bank rate with the so-called marginal standing facility (MSF) from February 13, 2012. As a result, the bank rate shot up from six per cent to 9.5 per cent. Currently, MSF and hence the bank rate are at nine per cent. Earlier this year, RBI increased the bank rate (BR) by 350 basis points, with immediate effect. Accordingly, the BR became 9.5 per cent a year with effect from February 13, as against six per cent a year earlier. However, most tax-free bond issues carry a coupon rate of 7-7.5 per cent. On a pre tax-basis, the return on these bonds amount to 11-11.5 per cent for an investor who pays tax at the rate of 30 per cent. A senior official at AK Capital, a lead manager for most tax-free debt issuances, said: "This rule has had a substantial impact on this year's tax-free bond issues. Companies have not been able to invest. The penalty for flouting that rule is also severe and a company official can be personally held liable." Some of the smaller companies are taking a chance by interpreting that the provision does not apply to bonds. Ajay Manglunia, senior vice-president, Edelweiss Financial Services, said, "Some companies did invest in the REC bond issue." He noted some of the big names, which invested last year, were missing. "I think that rule applies to inter-corporate deposits and not for such bonds. However, some large listed companies have stayed away, as they didn't want to take a chance," he said. The lack of clarity has already taken a heavy toll on the response. Arun Kejriwal of Kejriwal Research and Investment Services said the corporate response has been muted. "Only retail (investors), especially those in the 30 per cent tax bracket, have shown interest in these issues." The AK Capital official added, "It is an attractive proposition for companies with cash to invest in these issues, as the tax-free yield is much higher. The rule needs to be amended. I am sure the intention of the legislation was not to prevent companies from investing in such issues. However, it doesn't look like there could be an amendment soon, as it has to come from a higher level." – www.business-standard.com