Tax Loophole Hands Fis Interest Income Bonanza

Financial intermediaries stand to reap windfall gains from a loophole in the newly introduced tax concession section 10(23)G of the Income-Tax Act which has extended tax-free status to interest on all infrastructure-related bonds and long-term loans extended since April 1993.

The beneficiaries include foreign institutional investors (FIIs), Indian and foreign banks, financial institutions, corporates and non-banking finance companies.

Infrastructure related bonds which carry a coupon rate of 16-18 per cent were earlier taxable, while the non-taxable bonds like those issued by Indian Railway Finance Corporation offered interest rates of just around 9-10 per cent. However, after the income tax amendment initiated in the 1997-98 budget, the high-yielding bonds too now offer tax-free returns.

 

The amendment sought to kick-start investment in infrastructure by granting tax exemption to interest income from fresh bonds or long-term debt extended to infrastructure projects floated after April 1993. In other words, the exemption was meant to be applicable only to new funds raised by old projects. However, the wording of the section allows projects to claim benefits with retrospective effective.

It is a major gift by the finance minister to the Indian investor. It opens up lots of opportunities to the banks and financial institutions. But most of them have not read between the lines to take advantage of the provisions of the new section, says Arun Jain, director, V S Infrastructure Capital Ltd. Jain, who was among the first to discover the loophole. Jain has already made a presentation in this regard to the finance minister.

Further, the loophole ensures that the advantage will accrue not just to the primary subscriber of the bond but also to those who acquire it in the secondary market and hold it till the fiscal year-end. Banks and financial institutions can, therefore, save on some of their liabilities and post higher profits for the year.

Finance ministry officials admitted that all entities receiving interest income could claim tax exemption on the income earned in 1997-98 on these bonds. If the revenue department does not plug the loophole in the Union budget for 1998-99, then the special tax-free status of these bonds would be retained, sources said.

Several foreign banks have already built up strong positions in their respective portfolios. Money market players reveal that two Mumbai-based public sector banks too have acquired positions.

Among public sector bonds, those issued by National Thermal Power Corporation, Nuclear Power Corporation, Rajasthan State Electricity Board and Karnataka State Electricity Board after 1993 would be eligible for tax exemption.

These bonds, which carry a coupon rate of 16-18 per cent, will now trade at a higher premium as a result of the tax exemption bestowed upon them. Provident funds, which do not need the tax exemption status, had inherited a large chunk of these bonds through the private placement route. They now have the opportunity to make a killing by offloading their holdings.

Senior finance ministry officials admitted that the drafting of the new section had made it possible for existing infrastructure-related bonds to be eligible for the tax cover.