[2018]
93 taxmann.com 114 (Article)
Date of Publishing: April 25, 2018
Treatment of debentures issued by one company to another company
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DR K.R. CHANDRATRE
CS
Introduction
1. When a company plans to raise money by issuing debenture(s), usually five questions arise which
bother Company Secretaries, namely:
(1) Whether debenture is a security;
(2) Whether the money received against the debenture is a loan taken by the issuer-
company;
(3) Whether the money received against the debenture is a deposit taken by the issuer-
company;
(4) Whether the money paid for subscription to the debenture is an investment under
sections 179 and 186 of the Companies Act, 2013;
(5) Whether the money paid for subscription to the debenture is a loan under sections
179, 185 and 186 of the Companies Act, 2013.
Whether debenture is a security?
2. Section 2(30) of the Companies Act 2013 ("the 2013 Act") defines 'debenture as follows:
"debenture" includes debenture stocks, bonds or any other instrument of a company evidencing a
debt, whether constituting a charge on the assets of the company or not."
Section 2(81) of the 2013 Act defines the term 'securities' as follows:
"securities" means the securities as defined in clause(h) of section 2 of the Securities Contracts
(Regulation) Act, 1956 (42 of 1956)."
This is an extended definition. This definition was inserted in the Companies Act 1956 ("the 1956 Act")
by the Companies (Amendment) Act, 2000. As per the Securities Contracts (Regulation) Act, 1956 the
term "securities" is defined in section 2(h) as under:
"(h) "Securities" include—
(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable
securities of a like nature in or of any incorporated company or other body corporate;
1
[(ia) derivative;
(ib) units or any other instrument issued by any collective investment scheme to the
investors in such schemes;]
2
[(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;]
3
[(id) units or any other such instrument issued to the investors under any mutual fund
scheme;]
4
[Explanation.—For the removal of doubts, it is hereby declared that "securities"
shall not include any unit linked insurance policy or scrips or any such instrument or
unit, by whatever name called, which provides a combined benefit risk on the life of
the persons and investment by such persons and issued by an insurer referred to in
clause (9) of section 2 of the Insurance Act, 1938 (4 of 1938).]
5
(ie) any certificate or instrument (by whatever name called), issued to an investor by any
issuer being a special purpose distinct entity which possesses any debt or receivable,
including mortgage debt, assigned to such entity, and acknowledging beneficial
interest of such investor in such debt or receivable, including mortgage debt, as the
case may be;]
6
[(ii) Government securities];
(iia) such other instruments as may be declared by the Central Government to be
securities; and]
(iii) rights or interests in securities."
Strictly speaking, when a debenture is issued by a company (say A Ltd.) and another company (say B
Ltd.) subscribes to it and pays money to A Ltd. A Ltd. borrows money from B Ltd. against the
debenture.
Although the definition of 'debenture' says that it is an instrument of a company evidencing a debt,
debenture is a security within the ambit of this definition is obvious from the definition of 'securities'.
The question, as to whether Optionally Fully Convertible Debentures ('OFCDs') are securities within the
meaning of the definition of 'securities' in section 2(h) of the Securities Contracts (Regulation) Act, 1956
(which definition has been adopted by the Companies Act and the SEBI Act), was answered in the
affirmative by the Supreme Court in Sahara India Real Estate Corporation Ltd. v. Securities and
Exchange Board of India [2012] 174 Comp Cas 154. The Supreme Court also referred to the definition
of "hybrid" in section 2(19A) of the Companies Act 1956, which stated that "(19A) "hybrid" means any
security which has the character of more than one type of security, including their derivatives", and
held:
"For the purposes of the SEBI Act, the term "securities" is accepted as it is defined in section 2( h) of the
SC(R) Act. Section 2(h) of the SC(R) Act does not define the term "securities" exhaustively, because
clauses (i) to (iia) thereof, only demonstrate what may be treated as included in the definition of the
term "securities". And, clause (i) of section 2(h) of the SC(R) Act, includes within the definition of the
term "securities", inter alia, "bonds", "debentures" and "other marketable securities of a like nature".
For the present controversy it is sufficient to notice, that the appellant-companies through their
respective RHPs had invited subscription to, optionally fully convertible debentures (OFCDs). On
receipt of subscription amounts from investors, the appellant-companies had issued different kinds of
"bonds" (described as Abode Bonds, Nirman Bonds and Real Estate Bonds, by SIRECL; and Multiple
Bonds, Income Bonds and Housing Bonds, by SHICL). Since the term "hybrid" has been expressed as
". . .means any security. . ." there can be no doubt that a "hybrid" is per se a security. Moreover, the term
"security" in its definition includes ". . . other marketable securities of a like nature . . .". Therefore, even
if for one or the other reason, the OFCDs issued by the appellant-companies may not strictly fall within
the terms "debentures" or "bonds" (referred to in the definition of the term "securities") they would
nonetheless fall within the ambit of the expression "securities of a like nature". For this, the reasons are
as follows. The definition of the term "hybrid" also explains that a "hybrid" has the character of more
than one kind of "security" or their "derivatives". The term "securities" also includes "derivatives".
Therefore, even if the definition of the term "hybrid" is construed strictly, it would fall in the realm of
"securities of a like nature". And if, "securities of a like nature" are "marketable", they would clearly fall
within the expanse of the term "securities" defined in section 2(h) of the SC(R) Act (and therefore also,
section 2(1)(i) of the SEBI Act). The OFCDs/bonds issued by the appellant companies were also clearly
marketable, because the RHPs issued by the two companies provided, that the subscribers would be at
liberty to transfer the OFCDs/bonds, to any other person. Although, the transfer of OFCDs/bonds was
to be subject to the terms and conditions prescribed, and the approval of the appellant-companies. In
the absence of any prescribed terms and conditions barring transfer, the OFCDs/bonds were clearly
transferable, and therefore, "marketable". The term "marketable" simply means, that which is capable
of being sold. Allowing the liberty to subscribers to transfer the OFCDs/bonds made them
"marketable". There is therefore, no room for any doubt, that the term "hybrid", as defined in the
Companies Act, would squarely fall within the term "securities" as defined under section 2(1)(i) of the
SEBI Act (i.e., section 2(h) of the SC(R) Act).In view of the above it is clear, that "hybrids" are included
within the term "securities" not only for the purposes of Companies Act, but also, under the SEBI Act.
The SEBI therefore, would have jurisdiction even over "hybrids", even under the provisions of the SEBI
Act."
Subsequently, the above judgment of the Supreme Court was relied upon by the Income Tax Appellate
Tribunal, Delhi ("ITAT") in Dy. CIT v. Sahara India Commercial CorporationLtd. [2013] 38
taxmann.com 76/[2014] 147 ITD 176. In this case, during the Financial Year, 2004-05 relevant to the
assessment year 2005-06, the assessee accepted deposits under the nomenclature optionally fully
convertible debentures. The assessee showed Rs. 5171.40 crores under this head as unsecured loans in
the balance-sheet. The Assessing Officer held that the deposits were received in violation of provisions
of section 269SS of the Income-tax Act, 1961. The assessee contended that the deposits were securities.
The Assessing Officer rejected the contention and held that the amount received and paid under
optionally fully convertible debentures were loans and deposits and fell within the purview of section
269SS of the Act and levied penalty under section 271D of the Act. The Commissioner (Appeals) held
that the debenture issued by a company was a security and not a loan or deposit and, therefore, the
subscription monies received for the issue of debentures could not be equated with receipt of loan or
deposit within the meaning of section 269SS of the Act and, hence, cancelled the penalty levied under
section 271D of the Act. On appeal by the Department, the Tribunal held, dismissing the appeal, that the
terms "loan" and "deposit" had nowhere been defined in the Act. According to the Explanation 2 to
section 2(42A) of the Act, the expression "security" had the meaning assigned to it in section 2(h) of the
Securities Contracts (Regulation) Act, 1956. Section 2(h)(i) of the Securities Contracts (Regulation) Act,
1956 defines "securities" to include, inter alia, debentures or other marketable securities of a like nature
in or of any incorporated company or other body corporate. Optionally fully convertible debentures
were "securities"' under the Companies Act, 1956 as well as under the Securities Contracts (Regulation)
Act, 1956. Once the optionally fully convertible debentures were securities, they were neither" loans",
nor "deposits". When the optionally fully convertible debentures of the assessee did not fall under and
could not be equated with receipt of "loan" or "deposit" under the provisions of section 269SS of the
Act, no violation of that section could be committed by the assessee. Hence, penalty under section 271D
of the Act was not attracted.
Whether debenture is a loan?
3. Whether money paid by a company for subscribing to the debentures issued by another company, is
a loan given by the former, for the purposes of sections 185 and 186 of the 2013 Act, is the question that
now needs to be considered.
Section 2(30) of the 2013 Act (corresponding to section 2(12) of the Companies Act 1956) gives an
inclusive definition of the word "debenture", but nowhere in the Companies Act or any other law is to be
found a definition which is in the affirmative and exhaustive.
The dictionary meaning of the word "debenture" is "a certificate given by a business corporation, etc., as
a receipt for money lent at a fixed rate of interest until the principal is repaid". A debenture, in the
widest definition, is an acknowledgement of an existing debt. 7
In Levy v. Abercorris Slate & Slab Co,8
In British India Steam Navigation Co v. Commissioners of Inland Revenue, debenture was defined as
any document which either creates a debt or acknowledges it, and he says that any document which
fulfils either of those conditions is a debenture.9
The term 'loan' is not defined or explained in the sections 185 and 186 or elsewhere in the 2013 Act. In
its ordinary meaning, 'loan' means the act of lending; a grant of the temporary use of something;
something lent or furnished on condition of being returned, especially a sum of money lent at interest.
To lend means to grant the use of (something) on condition that it or its equivalent will be returned; to
give (money) on condition that it is returned and that interest is paid for its temporary use. Loan is
money lent on condition that it is repaid, either in instalments or all at once, on agreed dates and
usually that the borrower pays the lender an agreed rate of interest (unless it is an interest-free loan).
Loan means 'something lent, especially a sum of money; a sum of money lent at interest'. To lend means
to give out or allow the use of something temporarily on the condition that it or its equivalent in kind
will be returned; to provide money temporarily on the condition that the amount borrowed will be
returned often with interest. The making or giving of a loan, thus, involves an act of the giving of money
or something else by one person to another. There ought to be a positive act with an understanding that
the money something else so given will be returned by the taker thereof, i.e., the borrower, with or
without interest within an agreed period in any agreed manner.
According to Black's Law Dictionary 'loan' means a lending; delivery by one party to and receipt by
another party of a sum of money upon agreement, express or implied, to repay it with or without
interest. The essential requirement of a loan is the advance of money (or of some article) upon the
understanding that it shall be returned, and it may or may not carry interest. it was held that a
document which on the face of it was called a debenture and recorded indebtedness and was one of a
series was to be dealt with as a debenture.10
Loan is sometimes called 'advance' but there is no difference if the money given is called loan or
advance, if it is in the nature of loan, and unless the advance is in the nature of trade advance for
purchase of goods or services.
When a debenture is issued by a company, there are two parties to the transaction: the company which
received money on the debenture and the company which subscribes for the debenture and pays money
to the company issuing the debenture. So, the question arises, whether the company issuing the
debenture borrows money by way of a loan and the company which subscribes to the debenture gives
money as a loan. For the purposes of the provisions of sections 179, 185 and 186 of the 2013 Act.
Previously, under section 372A of the Companies Act 1956 (the predecessor of section 186 of the 2013
Act), there was an Explanation, which stated that "For the purposes of this section,— (a) "loan"
includes debentures or any deposit of money made by one company with another company, not being a
banking company". But it is not there in section 186 of the Companies Act 2013.
Section 185 or Section 186 of the Companies Act 2013 does not include any such Explanation and,
hence, if a company takes up debentures of another company, it need not be treated as a loan given but
can be treated as investment in securities. Section 186 applies to every investment by a company in
securities of a body corporate, such as equity or preference shares, fully or partly convertible/non-
convertible debentures or bonds, or other financial instruments, etc., issued by any company (private or
public) or other body corporate.
Thus, a debenture is not a loan for the purposes of sections 179, 185 and 186, but it is an investment in
securities. Accordingly, clause (d) of section 179(3) [to borrow monies] will not apply to the company
which issues debenture but clause (c) of that section [to issue securities, including debentures, whether
in or outside India] shall apply, and clause (e) of section 179(3) [to invest the funds of the company]
shall apply to the company subscribing for the debenture, but not clause (f) [to grant loans …]. Section
185 will not apply to the company subscribing for the debenture and section 186 will apply to the
company subscribing for the debenture as investment in securities of a body corporate.
Whether debenture is a deposit?
4. In such a case (debenture issued by a company and subscribed for by another company), the money
raised by debenture can qualify for the exemption under sub-clause (vi), even if such a debenture is a
non-convertible debenture and, therefore, it doesn't attract sub-clause (ix) of rule 2(1)(c) of the
Companies (Acceptance of Deposits) Rules, 2014 ('the Deposit Rules').
Section 2(31) of the 2013 Act defines "deposit" as follows:
"deposit" includes any receipt of money by way of deposit or loan or in any other form by a company,
but does not include such categories of amount as may be prescribed in consultation with the Reserve
Bank of India."
Rule 2(1)(c) of the Deposit Rules excepts certain kinds of monies received by a company from the ambit
of the definition of 'deposit'. In other words, the kinds of monies specified in rule 2(1)(c) do not amount
to deposits.
Rules 2(1)(c)(vi) and 2(1)(c)(ix) are as under:
"2. Definitions.—(1) In these rules, unless the context otherwise requires,—
** ** **
(c) "deposit" includes any receipt of money by way of deposit or loan or in any other form, by a
company, but does not include—
** ** **
(vi) any amount received by a company from any other company;
** ** **
(ix) any amount raised by the issue of bonds or debentures secured by a first charge or a charge
ranking pari passu with the first charge on any assets referred to in Schedule III of the Act
excluding intangible assets of the company or bonds or debentures compulsorily convertible into
shares of the company within five years:
Provided that if such bonds or debentures are secured by the charge of any assets referred to in
Schedule III of the Act, excluding intangible assets, the amount of such bonds or debentures shall
not exceed the market value of such assets as assessed by a registered valuer."
Clause (ix) above exempts from the definition of 'deposit' two types of debentures:
? First, debentures secured by a first charge or a charge ranking pari passu with the
first charge on any assets referred to in Schedule III of the Act excluding intangible
assets of the company (subject to compliance with the proviso); and
? Second, debentures (unsecured) compulsorily convertible into shares of the
company within five years (from the date of allotment).
Money received by a company by issuing any other type of debenture is a deposit.
Debenture issued by one company subscribed to by another company.-According to sub-clause (vi) of
rule 2(1)(c), any amount received by a company from any other company, is not a deposit. Under this
sub-clause any money received by a company from another company in any manner is not a deposit. If
both money-taking entity and money-giving entity are companies, such money would not amount to
deposit and the provisions of sections 73 to 76A of the 2013 Act, and the Deposit Rules will not apply to
it. Sub-clause (vi) exempts inter-company deposits.
The principle laid down in T. Radhakrishnan Chettiar v. Official Liquidator, Madras Peoples' Bank
Ltd. [1943] 13 Comp Cas 21 (Mad) and followed in Motilal Kejriwal v. Indian Overseas Airlines Ltd.
AIR 1959 Cal 117 with regard to registration of charges, is also relevant here.
In the first of the two cases, section 109 of the India Companies Act, 1913 required registration of
mortgage, while it was exempted from registration pledge. There was a transaction of bailment of
promissory notes to a fixed depositor as security for amount due to him and the question was whether it
required registration under section 109? The court held that, the transaction amounted to a bailment of
the promissory notes as security for the payment of the debt due to the depositor by the bank and being
a pledge did not require registration under section 109(1)(e) of the Act. It was held further, that section
109(1)(e) clearly contemplates that there can be a mortgage which is also a pledge. The transaction in
the present case might amount to a mortgage but as there were all the requirements for a valid pledge, it
did not require registration.
In the second of the two cases mentioned above, under a financing agreement a company handed over
possession of its aircraft to the mortgagee as security for the advances, property in the aircraft being
conditionally transferred to the latter until repayment of the moneys advanced to the company, the
question was whether the mortgage of the aircraft did not require registration under section 109(1)(e) of
the Indian Companies Act, 1913? It was held that section 109(1)(e), which dealt with the registration of
a mortgage or charge on any moveable property of a company, excepts from its operation (i) a mortgage
or charge which is a pledge, and (ii) a mortgage or charge on stock-in-trade. The section does not
require registration of a pledge of any moveable properly of a company.
It is a well-settled rule of statutory interpretation that if the words of the statute are in themselves
precise and unambiguous, then no more can be necessary than to expound those words in their natural
and ordinary sense. The words themselves do alone in such cases best declare the intent of the
lawgiver." [Sussex Peerage case (1844) 11 CI&F 85]. In Kanailal Sur v. Paramnidhi Sadhu Khan, AIR
1957 SC 907, Gajendragadkar J, had explained the literal rule in these words:
"The first and primary rule of construction is that the intention of the legislature must be found in
the words used by the legislature itself. If the words used are capable of one construction only then
it would not be open to the Courts to adopt any other hypothetical construction on the ground that
such construction is more consistent with the alleged object and policy of the Act. The words used
in the material provisions of the statute must be interpreted in their plain grammatical meaning
and it is only when such words are capable of two constructions that the question of giving effect to
the policy or object of the Act can legitimately arise. When the material words are capable of two
constructions one of which is likely to defeat or impair the policy of the Act whilst the other
construction is likely to assist the achievement of the said policy, then the Courts would prefer to
adopt the latter construction. It is only in such cases that it becomes relevant to consider the
mischief and defect which the Act purports to remedy and correct."
It is a settled rule of construction that the intention of the Legislature must be gathered from the words
used by the Legislature, for the words declare best the intention. The Legislature might have intended
to do a certain thing, but if the words employed do not express that intention, it is not for the courts to
assume the role of legislators and give effect to the unexpressed intention. No confusion must be
made… between what the draftsman might have intended to do and the effect of the language which, in
fact, was employed by him. If the words, which are a medium of expressing intention, fall short of
declaring the intention, it is for the Legislature to amend the language of the section. So far as the
courts are concerned, where the words are clear and precise, they must be given their natural meaning. 11
Concluding Remarks
5. Thus, any money received by a company from another company, regardless of the purpose or on
whatever account or in respect of whatever transaction it may be, will fall within the ambit of sub-clause
(vi); even if it falls it falls within the ambit of any other sub-clause of rule 2(1)(c) of the Deposit Rules.
For example, if A Ltd. paid B Ltd., some money against debentures issued by B Ltd. and subscribed for
by A Ltd. and the debentures are unsecured and/or not compulsorily convertible, such amount received
by B Ltd. will be eligible for exemption under sub-clause (vi). Similarly, a loan taken by a company from
another company is not a deposit as per rule 2(1)(c)(vi), provided the money-giving entity must be a
'company' incorporated under the Companies Act.
Accordingly, when a company issues and allots debentures to another company, the former received
money from the latter it can be treated as an "exempted deposit" under clause (vi) of rule 2(1)(c) of the
Deposit Rules.
■■
1. Inserted by the Securities Laws (Amendment) Act, 1999, w.e.f. 22-2-2000.
2. Inserted by the Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002, w.r.e.f. 21-6-2002.
3. Inserted by Securities Laws (Amendment) Act, 2004, w.r.e.f. 12-10-2004.
4. Inserted by Securities and Insurance Laws (Amendment and Validation) Act, 2010, w.r.e.f.
9-4-2010.
5. Inserted by the Securities Contracts (Regulation) Amendment Act, 2007, w.e.f. 28-5-2007.
6. Substituted for "(ii) Government Securities; and" by the Securities and Exchange Board of
India Act, 1992, w.e.f. 30-1-1992.
7. R v. Findlater (1940) 10 Comp Cas 149.
8. (1887) 37 Ch D 260.
9. (1881) 7 QBD 165.
10. See Dr. Fredie Ardeshir Mehta v. Union of India (1989) 2 CLA 244: (1991) 70 Comp Cas
210: (1991) 1 Comp LJ 437 (Bom).
11. Madanlal Fakirchand Dudhediya v. Shree Changdeo Sugar Mills Ltd. [1958] 28 Comp Cas
312 (Bom).
