India: Masala Bonds As A Tool To Finance Indian Joint Ventures Receives Budget Boost

Last Updated: 6 April 2017
Article by Ashwin Bishnoi, Aayushi Anand and Ankur Saxena

Most Read Contributor in India, August 2019

In our previous Newsflash dated 8 October 2015, 21 April 2016 and 8 August 2016, we had discussed the broad contours of issuance of Rupee denominated bonds overseas (Masala Bonds) under the Reserve Bank of India's (RBI) policy on external commercial borrowings (ECB) and how amendments introduced to the Masala Bond regime have paved the way for Indian issuers to access alternative sources of funds from the international market.

The Finance Act, 2017 was enacted on 31 March 2017 (Budget), which has provided further impetus to the issuance of Masala Bonds, especially considering the growing interest by offshore companies looking to debt-fund their Indian joint venture or sole venture operations in India.

Tax incentives

  1. Withholding Tax

    Under Section 194LC of the Income Tax Act, 1961 (IT Act), interest income earned by a non-resident/foreign company is liable to withholding tax at a concessional rate of 5% (subject to applicable surcharge and education cess), in case the debt is raised by an Indian company in foreign currency. While earlier the applicability of this provision to Masala Bonds was ambiguous, the Budget has now clarified that Masala Bonds would be eligible for withholding at the prescribed concessional rate. This amendment will extend to interest earned on Masala Bonds issued before 1 July 2020.
  2. Exemption from Capital Gains

    In a welcome move, the Budget has also amended Section 47 of the IT Act, exempting the transfer of Masala Bonds, from one non-resident bond holder to another from applicability of capital gains tax in India.
  3. Thin capitalisation norms

    The Budget, to the relief of many stakeholders, did not introduce any 'minimum capitalisation' requirements. It did, however, introduce 'thin capitalisation' norms under Section 94B of the IT Act, which would impact an Indian issuer's ability to deduct the interest expense on the Masala Bonds. In terms of the Budget, interest paid by an Indian company or permanent establishment of a foreign company to its 'associated enterprise' offshore, will not be allowed as deduction in computing the borrower entity's taxable income to the extent it arises from 'excess interest'. This is applicable to interest in excess of INR 10 million and where the total interest paid or payable is in excess of 30% of earnings before interest, taxes, depreciation and amortisation (EBITDA) of the issuer entity in the previous year or interest paid or payable to 'associated enterprises' for that previous year, whichever is less. The Budget has, however, permitted the Indian issuer entity to carry forward and set off such interest so disallowed, for 8 assessment years.

Raising Capital by Indian Joint Ventures

While the taxation benefits set out above have placed Masala Bonds at par with Rupee denominated non-convertible debentures (NCDs) issued in India and foreign currency bonds under the ECB regime, the following reasons make the Masala Bonds route more attractive for Indian joint ventures looking to raise funds from their non-resident shareholders:

  1. Eligible Borrowers and Subscribers

    Unlike the ECB regime, Masala Bonds can be issued by any Indian company, irrespective of the sector they are engaged in. Further, unlike Rupee denominated NCDs, Masala Bonds can be subscribed by any person from a FATF and IOSCO compliant jurisdiction without the requirement to register and be regulated by any regulator in India.
  2. Compliance requirements

    Issuers of Masala Bonds are exempted from several compliance requirements under the Companies Act, 2013 (such as requirement to maintain a debenture redemption reserve, issuance of private placement offer letter, etc), which are otherwise applicable in case of Rupee denominated NCDs. Additionally, in contrast to the ECB regime, there is no requirement under the Masala Bond regime for the issuer to maintain a liability to equity ratio in relation to the borrowing.

The Firm has advised several multinational companies and Indian joint venture partners on debt-funding Indian operations using Masala Bonds. We have seen that the above-mentioned advantages have resulted in fast deal timelines and closings in a manner that are beneficial to all parties.

Khaitan Comment

The Budget has provided the necessary fillip to investments in Masala Bonds as a mode of debt financing. With the concessional withholding tax rate, exemptions from compliance requirements under the Companies Act and a wider pool of eligible issuers, Masala Bonds are likely to be the flavour of the season for some time to come.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at

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