Compulsorily Convertible Debentures: Whether debt or equity?

Posted On - 9 April, 2024 • By - Vidushi Maheshwari

Compulsorily Convertible Debentures (CCDs), a hybrid instrument, has gained prominence in the last two decades. However, its classification as equity or debt has been the subject of discussions, mainly due to conflicting perspectives under different laws. This initial divergence surfaced from the framework of guidelines under the Foreign Exchange Management Act, 1999 (FEMA), which deemed CCDs as equity. However, in the realm of tax jurisprudence, CCDs have been treated as debt until the point of conversion. This conflict arises due to the hybrid nature of CCDs having the essence of both debentures and equity.

This issue recently resurfaced in IFCI v. Sutanu[i] (Judgment), wherein the discussion of the nature of CCDs was undertaken under the Insolvency and Bankruptcy Code, 2016 (Code) before the Hon’ble Supreme Court of India (Apex Court). Considering that different laws have treated the nature of CCDs differently, it becomes interesting to have a discussion to understand the nature of CCDs and its varied interpretations.

Factual background

The facts in this case were that IFCI had subscribed to CCDs in a Project Company, which was guaranteed by the sponsor of the project. Financial issues in the Project Company arose, leading IFCI and other creditors to initiate the corporate insolvency resolution process (CIRP). IFCI claimed its holding in CCDs as debt, but the resolution professional (RP) rejected it.  This decision of the RP was challenged before the National Company Law Tribunal (NCLT) and further at the National Company Law Appellate Tribunal (NCLAT); however, both the tribunals dismissed the appeal on the ground that CCDs were regarded as an “equity” and not a loan or debt.


The Apex Court while arriving at the conclusion that the nature of the CCDs is equity and not debt, analyzed the definition of “debt” under the Code and held that the definition of debt under section 3(11) of the Code is a liability or obligation in respect of a claim which is due from any person. The Project Company does not have any liability or obligation qua IFCI, because IFCI is actually an equity participant and does not have a debt to be repaid.

The Apex Court also interpreted the various clauses of the debenture subscription agreement executed between the parties and held that the liability to pay coupon payment was on the sponsor and thus, the Project Company had no obligation towards IFCI. The Apex Court also observed that unless it could be established that the debt belonged to the Project Company, IFCI cannot assert recovery as a creditor from the Project Company.

While interpreting the documents (including the concessional agreement and loan agreement between the parties), the Apex Court held “that a contract means as it reads. It is not advisable for a Court to supplement it or add to it”, which view was arrived by relying on an earlier precedent in Nabha Private Limited v. Punjab State Power Corporation Limited[ii].

In light of the above discussions, the Apex Court affirmed the decision of NCLAT, wherein it was held that treating CCDs as a debt, would tantamount to breach of the concessional agreement and the common loan agreement. The investment was clearly in the nature of debentures which were compulsorily convertible into equity and nowhere is it stipulated that these CCDs would partake the character of financial debt on the happening of a particular event.

Thus, the Apex Court conclusively determined that CCDs did not fall within the purview of a financial debt. Thus, IFCI, functioning as an equity participant, lacked a debt requiring repayment and could not have initiated CIRP.

CCDs under Insolvency and Bankruptcy Code:              

The determination of whether CCDs are debt or equity plays a vital role in the Code. Firstly, under CIRP, creditors form a part of the Committee of Creditors (CoC) which takes all decisions on behalf of the corporate debtor during CIRP. On the other hand, equity investors neither have any representation in the CoC nor is their consent required for any actions taken on behalf of the company once it is placed under CIRP.

Secondly, during liquidation of a corporate debtor, proceeds from the liquidation estate are distributed among stakeholders based on an order of priority known as the waterfall mechanism. As per the Code, creditors are ranked higher than equity investors. Equity investors are the last in line to receive the residue of proceeds after distribution to all stakeholders mentioned undersection 53 of the Code.

Various NCLT and NCLAT judgments have dealt with this issue with a common ratio coming out that the treatment of CCDs and accrued interests as a financial debt under the Code is to be determined on the facts of each case. One of the key factors determining the nature of the CCDs is the treatment in the financial statements, if the CCDs are termed as a debt (long term borrowings), then such CCDs are required to be treated as debt and not equity[iii].

NCLAT in Agritrade Power Holding Mauritius Limited and Ors. v. Ashish Arjunkumar Rathi, Interim RP of SKS Power Generation (Chattisgarh) Limited[iv] also provided an interesting insight wherein it held that even though CCD may be considered equity based on facts of the case, the interest accrued on such CCDs till the date of conversion can be considered as a financial debt.

CCDs under FEMA (Exchange Control Regulations):

Under the Foreign Exchange Management (Non-Debt Instruments) Rules of 2019, the term “equity instruments” means “equity shares, convertible debentures, preference shares, and share warrants issued by an Indian company”. “Convertible debentures” within this framework pertains to debentures that are fully, compulsorily and mandatorily convertible. Therefore, under FEMA, CCDs are regarded as “equity”. In its 2007 policy on foreign investment in debentures[v], RBI provided the rationale behind this:

It has been noticed that some Indian companies are raising funds under the FDI route through issue of hybrid instruments such as optionally convertible/ partially convertible debentures which are intrinsically debt-like instruments. Routing of debt flows through the FDI route circumvents the framework in place for regulating debt flows into the country. It is clarified that henceforth, only instruments which are fully and mandatorily convertible into equity, within a specified time would be reckoned as part of equity under the FDI Policy. “

CCDs under Income-tax:

Under the Income-tax Act, 1961 (ITA), in the context of CCDs, a primary issue which arises is whether interest paid on CCDs is an allowable deduction or not i.e., whether it is a loan on which interest should be allowed as a deduction. In accordance with section 36 of the ITA, interest paid on “borrowed capital” is eligible for deduction from taxable income. The question which arises for consideration is whether CCDs falls within the ambit of “borrowed capital”. In this context, the Hon’ble High Court of Rajasthan in the case of CIT v. Secure Meters Ltd[vi] has held that “debentures when issued is a loan, and therefore, whether it is convertible, or non-convertible, does not militate against the nature of the debenture, being loan, and therefore, the expenditure incurred would be admissible as revenue expenditure[vii].

Considering CCDs are regarded as equity under FDI, the Income-tax Appellate Tribunal, Bangalore in the case of ACIT v. CAE Flight Training (India) Pvt. Ltd[viii], also addressed this issue that the treatment of CCDs under FEMA doesn’t directly apply to the tax laws. The intent under FEMA to deem CCDs as equity is to prevent circumvention of regulations governing debt inflow into the country, and this context cannot be extended to the tax laws of India while determining interest on CCDs as an allowable deduction or not.

Accounting treatment of CCDs:

Reference is drawn to Indian Accounting Standard (Ind AS) 32, which addresses the accounting treatment of financial instruments including CCDs. The Institute of Chartered Accountants of India has consistently issued clarifications pertaining to the accounting nuances associated with CCDs.

In accordance with Ind AS 32, the classification of CCDs primarily is based on the contractual terms agreed between the parties. The broad determinative factor as per Ind AS 32 to term CCDs as equity or liability, amongst others, is whether the conversion is pre-determined or undetermined.   


CCDs as a hybrid instrument has seen a challenging journey, considering its nature has been subject to varied interpretations under different legislations. Each legislation had a different intent in treating CCDs in a particular manner. For FEMA, the reasoning was to exercise control on future repayment obligations, under the Code contractual terms and accounting treatment determined the nature and for income tax, the intent at the time of issuance was the determining factor to regard interest payments as a deduction.

With the above discussion, it can be stated that the nature of CCDs depends on the contractual terms, a fact-finding exercise of such terms and accounting treatment. Rather than terming difference of treatment under various laws as contradictory, the Courts have made it clear that each law operates autonomously. A fact-centric approach is imperative for a comprehensive understanding of the nature of CCDs.

It would be interesting to note that though CCDs may appear to be a lucrative instrument, the exact terms of CCDs will determine where an investor/creditor will stand in an insolvency proceeding. Documentation plays a significant role in determining the outcome on the nature of CCDs and as rightly observed by the Apex Court, while interpretating commercial documents, Courts should not endeavor to look into the implied terms of the contract. Thus, a contract means as it reads. In conclusion, an effort should be made to ensure that interests are protected in case of any contingency, insolvency being at the forefront.

Authors: Vidushi Maheshwari and Renjith Nair

Note: This Article was published by Law Street India on 08-04-2024

The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.

[i] CIVIL APPEAL NO.4929/2023

[ii] (2018) 11 SCC 508.

[iii] SGM Webtech Pvt Ltd vs Boulevard Projects Pvt Limited, C.P. No. (IB)-967/(PB)/2018.

[iv] MANU/NC/2096/2023.

[v] RBI/2006-2007/435 A.P. (DIR Series) Circular No.74, Available here.

[vi] [2010] 321 ITR 611 (Raj)

[vii] Recently followed by the Delhi Income-tax Appellate Tribunal in the case of Religare Finvest Ltd vs DCIT (ITA Nos.    4796/Del/2017 & ors.)

[viii] IT(TP)A No. 520/Bang/2022