Analyzing RBI’s Scheme on Structuring Big Ticket Stressed Assets

[The following guest post is contributed by Harsh Loonker, who is a 4th year student at the Jindal Global Law School, Sonipat]
India’s central banking institution, the Reserve Bank of India (RBI), has issued guidelines on a Scheme for Sustainable Structuring of Stressed Assets.[1]These guidelines would mark a significant shift in reactive measures undertaken by regulators to act in response to the increase in stressed assets in the banking and financial lending industry. The RBI has introduced this scheme in order to further strengthen the lenders’ ability to deal with stressed assets and to put real assets back on track by facilitating a rework of financial structures in entities facing genuine difficulties. This scheme envisages the determination of debt levels for a stressed borrower, and effectively bifurcates the outstanding debt into sustainable debt and equity instruments, which is expected to provide an upside on returns to lenders when the borrower’s business turns around. The Scheme is aimed at controlling and restructuring big-ticket accounts where the amount due is more than Rs. 500 crores. This post will look at some of the key provisions of the guidelines/scheme and the issues that need to be addressed by this regulatory framework.
According to RBI data, the stressed assets ratio, which includes non-performing assets (NPAs), of the banking sector, increased to 14.6% by the end of December 2015. This mark is against a 9.8% level that was noted towards the end of March 2012. It must be mentioned that state-run banks have the highest share in stressed loans. Their gross NPA, or bad loans, alone rose from Rs. 2.6 lakh crore in March of 2015 to an exorbitant Rs. 3.61 lakh crore in December of the same year. To better fight this rise in bad assets, the RBI has from time to time issued guidelines and norms over stressed assets intended for regulated lenders. Among efforts to revive borrowers, another restructuring scheme was issued last year called the Strategic Debt Restructuring Scheme (SDR). Complementary norms to this scheme called the Prudential Norms on Change in Ownership of Borrowing entities were also issued to address strategic change in ownership of the distressed business/companies or change in promoters of the borrower company.
Certain highlights and issued presented by this scheme
The scheme formulated by the RBI is an optional framework for structuring large distressed accounts. This scheme starts off by determining sustainable debt limits for the borrower facing financial distress. Then the scheme envisages bifurcation of the outstanding debt into sustainable debts on the one side and equity in the company or quasi-equity related instruments on the other. Already existing equity or security positions of lenders in the distressed company will not be affected by the scheme. The scheme lays out a detailed asset classification and provisioning of the same. In order to make sure the entire exercise is carried out in a prudent and transparent manner, the scheme envisages the plan for resolution to be prepared and implemented by credible professional agencies. A decision by the Joint lenders (JLF)/consortium of banks will be taken to resolve an account in issue. An overseeing committee will be formed and implementation will be made within 90 days.
In a nutshell, this scheme involves a substantial “write-down” of debt by dividing it into the above-mentioned categories. Earlier, lenders were able to co-ordinate deep financial restructuring with similar write-downs without being able to amend the bottom-line liability structure of the borrower facing stress. With the second category of equity and related instruments, banks have been given an incentive. Big-ticket lenders will now be able to structure and write down debts while offsetting the same with future payouts originating from owning equity in the borrower business. Market participants and stakeholders have requested such a scheme because this way companies under stress will be better able to deliver on their debt commitments without placing any moratorium on interest payments. As per the scheme, certain conditions are placed for an appropriate resolution plans, namely:
“a) There shall be no fresh moratorium granted on interest or principal repayments
b) There shall be not be any extension of repayments schedule or reduction in the interest rate for servicing, as compared to repayment schedule and interest rate prior to this resolution.”
The guidelines therefore do not allow for any change in the terms and condition of the loan in question. It must be mentioned that the entire scheme only supports projects/assets where commercial operations have commenced. Therefore, this scheme will not help lenders connected with major power projects, which are still under implementation, and facing financial difficulties. Further, only current cash flows connected with the asset are used as a basis while ascertaining sustainable debt. If unsustainable debt is more than cash flow, this scheme would be unviable.
In conclusion
This scheme is a welcome device for financial institutions to take curative measures in order to revive cases of stressed assets and to clear the books of accounts from bad loans. There are other measures available for lenders in addition to this scheme. Such as the ones available under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, the corporate debt restructuring framework and the Securities and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. But it must be mentioned that these regulatory schemes are only directed towards big ticket lending and do not concern retail lending for which there is a huge want in the market. Further, discussions on setting up special funds to resurrect troubled investments through equity infusion are already underway such as the stressed assets equity fund (SAEF) and stressed assets lending fund (SALF). SAEF will be set up to invest in equity of stressed borrowers bringing in fresh infusion of cash and SALF will provide working capital infusions, or low interest bridge loans for borrowers facing funding constraints. These regulatory measures in concert will increase banking and lending confidence at a time where NPAs are on a rise.
Harsh Loonker

India-Mauritius DTAA Protocol: Analyzing the Impact

[The following guest post is contributed by Aarush Bhatia, who is a 5th year B.A.LL.B (Hons.) student at CNLU, Patna]
The protocol[i]dated 10 May 2016 amending the Double Taxation Avoidance Agreement (DTAA) between India and Mauritius is arguably the most significant changerelating to direct taxes in India in recent years, considering that approximately a third of all foreign investments into India are structured through Mauritius. The shift to source based taxation of capital gains from the hitherto residency based taxation is its most important feature.
To summarize, capital gains arising on sale of shares of an Indian company by a Mauritian resident shall be taxable in India (where the source of income lies) as against the earlier position of taxability in Mauritius (based on the residency of the seller). Since the amended protocol refers to shares, both equity as well as preference should be covered. The government has however, mitigated the immediate impact of the protocol on investorsby grandfathering all investments made through Mauritius in shares of Indian companies until 31 March 2017. The protocol provides for a relaxation in respect of capital gains arising to Mauritius residents for shares acquired on or after 1 April 2017 and sold before 1 April 2019, i.e. the transition period. The tax rate on any such gains shall be limited to 50% of the domestic tax rate in India, subject to a limitation of benefits (LOB) clause. The LOB clause states that the benefit of the reduced tax rate shall only be available to such Mauritius resident who is:
(a) not a shell/conduit company; and
(b) satisfies the main purpose and bonafide business test.
It provides that a Mauritius resident shall be deemed to be a shell/conduit company if its total expenditure on operations in Mauritius is less than INR 2,700,000 (approximately 40,000 US Dollars) in the 12 months immediately preceding the alienation of shares. The capital gains tax shall be levied at its full rate only after 1 April 2019.
Impact Analysis
While the manner in which the protocol is sought to be brought into effect is venerable, a more detailed analysis is required in order to fully understand its ramifications on foreign investors. Some of the protocol’s latent ambiguities and wider impact have been scrutinized in this post.
1.         Taxation of Hybrid Instruments
The press release is silent about hybrid instruments like compulsory convertible debentures and futures and options transactions. For instance, foreign investors invest into Indian companies through convertible instruments, with the most common being compulsorily convertible debentures. If such instruments are converted after 1 April 2017, can it be said that the shares are acquired after 1 April 2017 and accordingly taxed in India? It needs to be seen whether any benefit can be obtained from the recently introduced Rule 8AA of the Income-tax Rules, 1962 (which provides that the period of holding shall include, the period for which debenture is held prior to conversion) for determining the date of acquisition of shares.[ii] This issue needs to be clarified under  the text of the protocol as and when it is released by the Central Board of Direct Taxes (CBDT).
2.         Impact On Other Beneficial DTAAs
The protocol has a contagion effect on other DTAAs as well. The position on capital gains under Article 6 of the India-Singapore DTAA is co-terminus with the benefits available under erstwhile provisions on capital gains contained in the treaty with Mauritius. Consequently, with the amendment in India- Mauritius DTAA, alienation of shares of an Indian Company by a Singapore Resident after 1 April 2017 may not necessarily be entitled to obtain the benefits of the existing provision on capital gains as the beneficial provisions under the India-Mauritius DTAA would have terminated on such date. However, clarity is required with regard to grandfathering and transition period provisions.[iii]Further, India has asked the Netherlands to resume negotiations on amending their bilateral tax treaty as the government extends its efforts to plug loopholes in such accords to curb misuse. The Dutch tax treaty, which allows exemption from capital gains and a lower rate of tax on dividends, has led to the proliferation of holding company structures.[iv]While Cyprus is the only other nation whose treaty presently offers capital gains tax exemption to investors, it had been a notified non-cooperative jurisdiction since 2013 for failure to share adequate data on tax evaders.  The government has now got Cyprus to similarly amend the India-Cyprus DTAA. According to the new agreement, Cyprus investors’ capital gains on investments made in Indian companies after March 31, 2017 can be taxed in India. These provisional agreements are awaiting Cabinet approval.
It is speculated that Cyprus has agreed to give India the right to tax capital gains similar to the provision in the revised India-Mauritius tax treaty subject to being removed from the blacklist.
3.         Indirect Transfers
While the direct transfer of Indian company shares by a Mauritius resident after 1April 2017 shall be taxable in India, indirect transfers may still remain out of the Indian domestic tax net. To illustrate, in a structure where there are two Mauritius companies say M Co 1 and M Co 2 wherein M Co 1 holds shares of M Co 2 which in turn holds Indian company shares and derives substantial value from India. In such a situation transfer of shares of M Co 2 by M Co 1 leading to an indirect transfer of Indian company shares may still not be taxable in India.[v]
4.         Group Reorganizations
A clarification would also be required regarding application of grandfathering in case of shares allotted to a Mauritius resident pursuant to a merger or demerger in lieu of shares held in the merging or the demerged entity which were acquired before 1 April 2017.[vi]
5.         Most Favoured Nation (MFN) Clause
The lowering of withholding tax (WHT) on interest to 7.5% under the new protocol has provided succour in favour of debt securities like CCDs. While the WHT of 7.5% is lower than the one provided in other DTAAs like Netherlands (10%), Singapore (15%), UAE (12.5%), etc., most DTAAs entered into by India contain MFN clauses, pursuant to which if India enters into a Convention, Agreement or Protocol with another country which reduces the tax rate of items of income like interest income, then such reduced tax rate shall apply in case of their DTAA as well. It remains to be seen whether the rate of WHT under other DTAAs will automatically reduce as a consequence of the protocol.
6.         Impact on Investment Through Participatory Notes (P-Notes)
P-Notes are derivatives issued by FIIs to investors for the underlying securities invested by the FIIs on the Indian stock markets. Mauritius was the most suitable jurisdiction to invest through P-Notes as several FIIs were setup in Mauritius to avail of the India-Mauritius tax treaty benefits. The P-Notes enjoyed the same capital gains benefit as the FIIs enjoyed at the time of transfer of shares by the FIIs on the Indian securities.This benefit would now cease to be available. While it can be argued that GAAR would have checked treaty abuse anyhow without amending the treaty, it is speculated that the real reason behind this amendment seems to be to restrict investments through P-Notes to prevent round-tripping of money. Withdrawal of the treaty benefits would make this route unattractive for such investors.
The protocol seems to be the final chapter in along drawn tussle between investorsand the revenue. The phased manner of withdrawal of benefits by the government is laudable, especially after its retrospective taxation misadventure post the Vodafone case. While the press release clears the air regarding treaty benefits in no uncertain terms, its collateral impact as analyzed would be clear only after the text of the protocol is releaased. The details of the ‘main purpose’ test and the ‘bona fide purpose’ test stated in the press release too are unclear. There is a possibility that these tests may be subjective and lead to some uncertainty regarding the taxability of investments made during the Interim Period.

Aarush Bhatia

[i]Protocol for amendment of the Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains between India and Mauritius available at
[ii]Sahil Aggarwal, Protocol to India-Mauritius DTAA: A move towards avoidance of double non-taxation, available at
[iii] Ibid
[iv]DeepshikhaSikarwar, After Mauritius, now government wants to amend Dutch tax treaty; asks Netherlands to resume talks, (Economic Times, May 30th 2016) available at
[v] Amit Bahl, Harsh Biyani and SurbhiBagga, Protocol amending India-Mauritius DTAA: Key changes and their impact, available at