Govt clarifies on investment in tax-free bonds by companies

Ambiguity over a clause in the Companies Act that disallows corporates from investing in tax-free bonds at a rate of interest lower than the prevailing bank rate was seen as hurting investments into tax-free bonds

The ministry of corporate affairs (MCA) on Thursday said companies can invest in tax-free bonds where the effective rates are higher than the prevailing bank rates, a move that would help in attracting more investments into such instruments.

Ambiguity over a clause in the Companies Act that disallows corporates from investing in
tax-free bonds at a rate of interest lower than the prevailing bank rate was seen as hurting investments into tax-free bonds.

Making the clarification, the ministry has said corporate investments in tax-free bonds having higher interest rates (effective rate of returns) than prevailing rates would not violate the Companies Act.

“...where the effective yield (effective rate of return) on tax free bonds is greater than the yield on prevailing bank rate, there is no violation of Section 372(A) of Companies Act, 1956," the ministry said in a circular dated 14^th March.

The circular is effective from 14^th March.

A clarification on the issue was sought by the finance ministry in order to effectively implement the Budget proposals.

In the Union Budget for 2013-14, the government authorised raising of up to Rs50,000 crore through issue of tax-free bonds.

 

As per the Companies Act, “no loan to anybody corporates shall be made at a rate of interest lower than the prevailing bank rate, being standard rate made public under Section 49 of the Reserve Bank of India Act...”

Such bonds carry a lower rate of interest—at present in the range of 6.75% to 7.50%. These instruments are also allowed in the current financial year but the response has been relatively poor.

According to the circular, the poor response was mainly on account of the restriction in terms of Companies Act—where tax free bonds cannot have rates higher than the prevailing interest rate.