Govt clarifies provision for corporate investments in tax-free bonds

The government today clarified that tax-free bonds are eligible investments for companies in a bid to boost corporate participation in such instruments.

The government's move comes after ambiguity over interpretation of a provision in the Companies Act relating to inter-corporate deposits affected investments by corporate bodies in tax-free bond issuances. "It's 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 the Section 372A(3) of Companies Act, 1956," the ministry of corporate affairs said in a circular.

The Section 372A(3) of the Companies Act says: "No loan to any corporate body 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 per cent, while the coupon rate offered by such instruments are in the range between 6.85 per cent and 7.2 per cent. As a result, most companies were staying away from investing in such instruments for fear of breaching the Company Act provision.

The bank rate was untouched at six per cent since 2003. Last month, RBI as a "one-time technical adjustment" decided to align the bank rate with the so-called marginal standing facility (MSF), from where banks can borrow overnight, effective February 13. As a result, the bank rate shot up from six per cent to 9.5 per cent. Currently, both MSF and the bank rate are at 8.75 per cent.

The six tax-free bond issues currently in the market are finding it challenging to garner subscription. The corporate affairs ministry in a statement attributed the tepid 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 per cent 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 the ministry in a statement.