One intra-group funding structure that enjoys the advantages of equity-like funding, but debt-like flexibility, especially under the IndAS regime, is the use of unsecured, perpetual ICDs/ debentures.
Key Considerations:
A. Commercial Lens:
– ICDs/ Instruments are perpetual, with discretionary repayment of both principal and coupon, both in terms of the quantum of repayment and the timing
– Economically, perpetual ICDs/ equity behave like equity: subordinated to all third-party lenders, absorb losses first, forms the junior-most layer and provide capital without mandatory service obligations.
– Yet, promoters/ holding company retain the ability to repatriate funds without dealing with the tax/ regulatory constraints applicable to buyback/ capital reduction.
B. IndAS: IndAS treats perpetual ICD/ NCDs as equity funding, if the maturity is truly perpetual with a discretionary interest and redemption in terms of quantum/ time period. As a result, there is no leverage added on the balance sheet, and any “interest” goes below the line, akin to a dividend, and not an interest charge to the P&L, preserving EBITDA and debt covenants.
C. Companies Act / ODI Check
– For Companies Act purposes, this is not “share capital” (even though it is classified as equity in the books), and therefore, does not form part of “net worth”, as defined.
– Same issue spills over to FEMA ODI: for outbound investments, this quasi-equity would not be counted towards net worth, even though it is equity under Ind AS.
D. Tax Angle: From an income-tax perspective, any coupon on a perpetual ICD / debentures, if and when actually paid, should be available as a deduction to the issuer, subject to the usual tests of wholly and exclusively for business purposes.
E. Section 186(7) – Interest Benchmarking: 186(7) of the Companies Act, 2013 pegs minimum interest on loans to the prevailing G-Sec yield for a matching tenor. Perpetual ICD / debentures have no fixed tenor, so there could be a strong argument that 186(7) should not mechanically apply since there is no comparable G-Sec benchmark by definition.
E. IBC Angle: Since the perpetual ICDs/ debentures have no fixed maturity, with no enforceable obligation to repay principal or pay coupon, it should not be considered as a financial debt from an IBC perspective.
Key Takeaway: Perpetual ICDs / NCDs are a quasi-equity tool treated as equity for Ind AS/ books, retaining the flexibility of repayment in due course.