Govt 'clarifies' to boost corporate participation in tax-free bonds

Currently, bank rate is at 8.75%, while coupon rate offered by such instruments are between 6.85% and 7.2%

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To boost corporate participation, the centre today clarified that the tax-free bonds are eligible investments for companies.

Ambiguity over interpretation of a provision in the Companies Act relating to inter-corporate deposits had affected investments by corporate bodies in tax-free bond issuances.

In a circular, the Ministry of Corporate Affairs (MCA) said, “It is hereby clarified that in cases where the effective yield on tax free bonds is greater than the yield on prevailing bank rate, there is no violation of Section 372A(3) of Companies Act, 1956.”

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."

Currently, the bank rate is at 8.75%, while the coupon rate offered by such instruments are in the range between 6.85% and 7.2%. As a result, most companies were staying away from investing in such instruments for fear of breaching the company law provision.

The bank rate was untouched at 6% 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% to 9.5%. Currently, MSF and hence the bank rate is at 8.75%.

The six tax-free bond issues currently in the market are finding it challenging to garner subscription. The ministry of corporate affairs in a statement attributed the lukewarm response to restriction under Section 372A(3) .  

Next year the government has allowed fund raising to the tune of Rs 50,000 crore through tax-free bond issuances. Lack of clarity would have impacted investments of up to Rs 5,000 crore, as up to 10% of bond public issues are reserved for corporate subscribers.

In addition, some issuers had planned to raise funds through private placement for big-ticket corporate and institutional investors.

“This clarification puts to rest the ambiguity on eligibility of investments by corporate bodies, in tax free bonds, currently on offer,” said MCA in a statement.