(This article was first published in Taxsutra)
Background
Perpetual debentures, in the Indian context, refer to debt instruments issued without a fixed maturity date, and in respect of which both the coupon servicing and the principal repayment are discretionary in the hands of the issuer, in terms of quantum as well as timing. The legal form of the instrument continues to be that of a debenture under the Companies Act, 2013, but the substance, on account of the absence of any enforceable repayment or servicing obligation, is closer to that of equity. The holder provides permanent capital to the issuer without any contractually mandated return.
The instrument, however, is characterised differently by each of the regulatory and tax frameworks that apply to it. Ind AS 32 classifies it as equity where the issuer has no unconditional obligation to deliver cash. The Companies Act treats it as a debenture and does not include it in the Section 2(57) definition of net worth. The income-tax law allows the coupon as a deductible expense under Section 36(1)(iii) of the Income Tax Act, 1961 (“IT Act”)[1] on the basis of the legal form, but the transfer pricing machinery and the thin capitalisation provisions under Section 94B of the IT Act[2] reserve the right to test the substance. FEMA does not recognise perpetual debentures as an equity instrument under the FEM (Non-debt Instruments) Rules, 2019, which means inbound investment through this route is not permissible, effectively confining the structure to domestic groups. Under the IBC, the holder is not a financial creditor under Section 5(8), and sits below all financial creditors in the Section 53 waterfall.
The analysis of the instrument, therefore, cannot be conducted in the abstract. It must be embedded within the specific commercial scenario being addressed, with the regulatory and tax consequences mapped to that scenario. The sections that follow set out four commercial scenarios in which perpetual debentures have a role to play, with the regulatory and tax mapping conducted within each scenario, followed by the big picture.
Scenario 1: Long-Horizon Intra-Group Funding Without Dilution
The Commercial Problem
A promoter intends to fund a group company on a long-horizon basis, in a situation where co-investors already hold equity in the target. A fresh equity issuance to the promoter would dilute the co-investors, which would either require their consent under the shareholders’ agreement, or, at the very least, alter the equity ownership pattern in a manner which the co-investors may not have contemplated at the time of their original subscription. A CCPS or a CCD, while not diluting the co-investors immediately, would convert into equity on a future date, and would therefore lead to the same outcome at the point of conversion, only deferred in time. An OCD would carry an enforceable coupon and redemption obligation, and would not, therefore, deliver the equity-like permanence that the commercial scenario requires.
Why the Perpetual Works
A perpetual debenture, by retaining the legal form of a debenture, does not entitle the holder to any equity participation, and at the same time, by keeping the coupon and the principal repayment discretionary, does not impose any service obligation on the issuer. The promoter achieves a quasi-equity investment that protects the equity of the co-investors and does not trigger any debt covenants.
Regulatory and Tax Consequences
Ind AS 32: Since the issuer does not have an unconditional obligation to deliver cash or another financial asset, the instrument is classified as equity. The coupon, when paid, sits below the line as an appropriation akin to a dividend, and the instrument does not enter the leverage numerator. This classification is, however, sensitive to the precise terms of the instrument. Any feature that creates an indirect compulsion to repay or to service the coupon, such as a step-up coupon that escalates to a punitive rate after a defined period, or a put option in the hands of the holder, would collapse the equity classification and reclassify the instrument as a financial liability.
Companies Act and FEMA: The instrument remains a debenture and does not enter the statutory definition of net worth under Section 2(57). For FEMA, a perpetual debenture is not recognised as an equity instrument under the Non-debt Instruments Rules, which means inbound investment through this instrument is not permissible under the automatic route. The structure is therefore confined to domestic groups. For outbound investments, the perpetual is not counted towards the net worth of the Indian investor for the purposes of computing the limit for making financial commitment under the FEM (Overseas Investment) Rules and Regulations, 2022.Further, overseas direct investment is where the Indian investor acquires 10 percent or more of the equity capital, or acquires control, of the foreign entity, which would not be achieved through perpetual instruments, but once the Indian entity holds 10% or more in the foreign entity, it could fund the foreign entity through perpetual debentures.
Direct Tax – Section 36(1)(iii) Deductibility: The coupon, when actually paid, is deductible under Section 36(1)(iii) of the IT Act, since the legal form remains that of a debenture under the Companies Act. The Ind AS classification as equity does not override the legal form for income-tax purposes.
Direct Tax – Transfer Pricing Recharacterisation Risk: Where the perpetual is issued to an associated enterprise, the transfer pricing officer has the jurisdiction to examine the arm’s length characterisation of the instrument itself, and not merely the rate of interest. The risk is that the TPO may recharacterise the perpetual as equity on the basis that no independent third party would have provided capital on such terms, i.e., with no fixed maturity, no mandatory coupon, and full subordination to all other creditors. The consequence of such recharacterisation would be the disallowance of the coupon as a deductible expense.
This risk is not hypothetical. In the recent ITAT Mumbai order in Tata Chemicals Ltd.[3], the Tribunal upheld the recharacterisation of non-cumulative preference share investment in the assessee’s Mauritius subsidiary as a loan in substance. The TPO had found that the preference shares carried no real expectation of return, yielded no dividends, and effectively functioned as a funding arrangement rather than a capital investment. The Tribunal agreed, benchmarked the transaction as a loan at LIBOR plus 200 basis points, and sustained the imputation of notional interest. While the instrument in that case was a preference share rather than a perpetual debenture, the analytical framework is identical: where the substance of the instrument does not match its legal form, the TPO can look through the form and recharacterise the instrument for transfer pricing purposes.
Direct Tax – Section 94B Thin Capitalisation: Where the perpetual is issued to a non-resident associated enterprise (AE), the coupon paid on the perpetual would be subject to the interest limitation under Section 94B of the IT Act, which restricts the deduction of interest paid to a non-resident AE to 30 percent of the EBITDA of the borrower, or the interest paid to the AE, whichever is less, subject to a de minimis threshold of INR 1 crore. The disallowed excess can be carried forward for up to eight assessment years. Importantly, Section 94B also catches back-to-back arrangements: where the perpetual is issued to a domestic lender but the AE provides an implicit or explicit guarantee, the debt is deemed to have been issued by the AE. The interaction of Section 94B with the Ind AS equity classification produces an asymmetry: while the instrument is equity under Ind AS, the coupon is treated as interest for the purpose of the thin capitalisation ceiling, which is a consideration to be borne in mind in any cross-border deployment of the instrument.
IBC: The holder is not a financial creditor under Section 5(8), since there is no enforceable obligation to repay. This structural subordination provides comfort to external lenders of the target, in that the perpetual holder does not compete with them in the Section 53 waterfall. The flip side is that the promoter’s capital is first-loss in the event of distress: if the issuer enters insolvency, the perpetual is not admitted as a claim in the CIRP, and the entire resolution value is available to the financial and operational creditors. This is the risk-remote trade-off inherent in the instrument, and it is a trade-off that the promoter should consciously accept at the time of issuance.
Scenario 2: Funding a Stressed Subsidiary Where Senior Lenders Are in Place
The Commercial Problem
A promoter intends to fund a stressed subsidiary in which senior lenders are already in place under loan documentation containing debt-to-EBITDA and debt-to-equity covenants. A plain debt funding would worsen the leverage ratios and could trigger an event of default. A fresh equity issuance, while preserving the covenants, would dilute existing co-investors.
Why the Perpetual Works
Where the perpetual is classified as equity under Ind AS 32, it sits below the line and does not enter the numerator of the leverage covenant computation. This treatment is, however, subject to the senior lenders accepting the Ind AS classification for the purpose of computing the covenants, since the loan documentation could, in principle, define “indebtedness” in a manner that captures perpetual debentures regardless of their accounting treatment.
Regulatory and Tax Consequences
Ind AS 32: Equity classification preserves reported EBITDA, since the coupon is a below-the-line appropriation. The instrument stays off the leverage numerator.
IBC – The Risk-Remote Dimension: The risk-remote feature is particularly relevant here. If the subsidiary enters insolvency notwithstanding the funding, the promoter’s perpetual is not admitted as a claim, and the external lenders have the entirety of the resolution value available to them. The perpetual, in this scenario, functions as a structural first-loss cushion provided by the promoter to the senior lenders, which is, in many cases, precisely the comfort that the senior lenders require before accepting the Ind AS classification for covenant purposes.
Direct Tax: The same Section 36(1)(iii) deductibility applies. Where the subsidiary is a domestic company funded by a domestic promoter, the transfer pricing and Section 94B risks described in Scenario 1 do not arise, which is one of the reasons the instrument works most cleanly in a purely domestic, intra-group context.
Scenario 3: Capital Reduction Consideration – Crystallising Loss, Preserving Repayment
The Commercial Problem
A promoter holds preference shares in a company whose net worth has been substantially eroded. The FMV of the preference shares is nominal. The promoter wants to crystallise the capital loss for set-off against other capital gains, while preserving the company’s repayment capacity in respect of the original subscription amount. This is the use case which has been examined in some detail in the author’s earlier article on capital reduction as an instrument conversion mechanism, where the thesis is that Section 66 permits capital reduction in any manner, including the conversion of equity or preference shares into a debt instrument, a perpetual instrument, or a liability, and the consideration for the capital reduction need not be confined to cash.
Why the Perpetual Works
Where the consideration for the capital reduction takes the form of perpetual debentures, two quantities are deliberately decoupled. The FMV of the perpetual debentures, which would be nominal given the eroded net worth, drives the capital gains computation under the income-tax law. The face value of the perpetual debentures, however, is retained at the original subscription amount, which preserves the contractual repayment capacity on the balance sheet, to be settled at the issuer’s discretion in the future. FMV drives the tax outcome; face value drives the balance sheet. The deliberate decoupling of FMV from face value is the structural core of the transaction.
Regulatory and Tax Consequences
Direct Tax: The capital loss in the hands of the shareholders equals the cost of acquisition of the shares less the FMV of the perpetual debentures received as consideration. The FMV is computed under Section 50CA read with Rule 11UA of the IT Act[4], and in the case of a company with eroded net worth, the FMV would be nominal, resulting in a near-complete crystallisation of the capital loss for set-off against other capital gains. The FMV under Ind AS 113 read with Ind AS 109 (Appendix D) anchors the full value of consideration under the income-tax law.
Companies Act: Section 66 permits capital reduction “in any manner”, followed by clauses specifying extinguishment of unpaid liability and cancellation of paid-up capital. A recent NCLAT ruling confirmed that the company has the discretion to reduce share capital in any manner, including conversion into an unsecured loan or a perpetual instrument. The route requires a special resolution under Section 66 and NCLT sanction, but there is no buyback cap, no free reserves test, and no cooling-off period.
Ind AS: The cancelled preference shares are replaced by a perpetual classified as equity under Ind AS 32, so the leverage profile of the issuer does not change.
Scenario 4: Repatriation of Promoter Capital Without Buyback or Capital Reduction Friction
The Commercial Problem
A promoter who has funded a company by way of equity shares on a long-horizon basis wants to repatriate surplus capital when the company has accumulated excess cash. The most intuitive routes for returning capital to equity shareholders are a buyback under Section 68 and a capital reduction under Section 66.
Why These Routes Carry Friction
Under the Finance Act, 2026 (effective 1 April 2026), buyback consideration is once again taxable as capital gains in the hands of the shareholder, and an additional tax for promoter buybacks (equating the tax rate to dividend tax), reversing the deemed-dividend characterisation under Section 2(22)(f) under the IT Act that had applied for buybacks between 1 October 2024 and 31 March 2026. Cost of acquisition is allowed as a deduction. However, the buyback continues to carry the following constraints: the 25 percent cap under Section 68 on paid-up capital and free reserves, the source-of-funds restriction linked to the availability of free reserves, the cooling-off period between successive buybacks, and, for promoter shareholders specifically, an additional differential levy over and above the standard LTCG or STCG rate. A capital reduction under Section 66, while not subject to the buyback cap, requires NCLT sanction. In either case, the route is procedurally and fiscally expensive.
Why the Perpetual Works
Had the promoter, instead of subscribing to equity shares, subscribed to perpetual debentures at the outset, the repatriation would not require a buyback or a capital reduction at all. The issuer can redeem the perpetual, in whole or in part, at its discretion, without any statutory ceiling on the amount, without any free-reserves condition, without any cooling-off period, and without any tribunal process. The redemption proceeds in the hands of the holder would be treated as a transfer of the debenture, with cost of acquisition allowed as a deduction, and the capital gains taxed at the applicable rate. No deemed-dividend characterisation applies, since the instrument is not a share and Section 2(22) of the IT Act[5] does not extend to redemption of debentures. No promoter differential levy applies, since the levy is specific to buybacks. The perpetual, in this scenario, functions as a pre-built exit pipe which is structurally superior to both buyback and capital reduction from a procedural, regulatory, and tax perspective.
The Big Picture
The structuring exercise around perpetual debentures is, at its core, an exercise in the deliberate exploitation of the asymmetry between legal form and economic substance, across frameworks which do not speak to each other. Ind AS 32 reads the substance and arrives at equity. The Companies Act reads the form and continues to treat the instrument as a debenture. The income-tax law reads the form for the purpose of allowing the coupon as a deductible expense, but reserves the right, through the transfer pricing machinery and the thin capitalisation provisions, to read the substance for cross-border transactions. The ITAT’s order in Tata Chemicals is a reminder that this right is not theoretical. FEMA reads neither the form nor the substance in a manner that supports inbound deployment. The IBC reads the substance and places the holder below the financial creditors, which is both a constraint for the holder and a comfort for other lenders.
The instrument, in other words, does not have a single identity. It has as many identities as the frameworks that apply to it. And that is precisely where both the power and the risk of the instrument reside. The power lies in the ability to present the right identity to the right framework at the right time: equity to the auditor, debt to the tax officer, subordinated capital to the lenders, and a pre-built exit pipe to the promoter. The risk lies in the possibility that one of the frameworks may refuse to accept the identity presented, or that the commercial terms may, inadvertently or otherwise, create a feature that collapses the equity classification under Ind AS and, with it, the entire structural rationale.
The discipline, therefore, lies not in the selection of the instrument, but in the precision with which the terms are calibrated to the specific commercial scenario, and in the verification that each of the applicable frameworks, taken independently, arrives at a characterisation which is consistent with the commercial outcome sought to be achieved. Where the scenario is purely domestic, intra-group, and long-horizon, and the promoter consciously accepts the first-loss position under the IBC, the perpetual debenture is amongst the most elegant instruments available. Where cross-border elements are introduced, the transfer pricing recharacterisation risk and the Section 94B thin capitalisation ceiling enter the analysis and need to be separately evaluated. Where FEMA applies from an inbound perspective, the instrument does not work at all. The right question, accordingly, is not whether a perpetual debenture can be issued, but which hat the commercial purpose requires, and whether the other hats, taken together, leave the structure intact.
[1] Section 32(b) of Income Tax Act, 2025
[2] Section 177 of Income Tax Act, 2025
[3] Tata Chemical v. DCIT (ITA No. 7912/MUM/2019, order dated 4 February 2026, AY 2015-16)
[4] Section 79 of the Income Tax Act, 2025, read with Rule 57 of the Income Tax Rules, 2026
[5] Section 2(40) of the Income Tax Act, 2025