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