Foreign firms may now have to think twice before advancing money to Indian firms by subscribing to their bonds because a recent ruling by a tax authority has clarified that such interest income by foreign firms is taxable here.

Giving the ruling in the case of US-based LMCC, the Authority for Advance Ruling said, 'Payments made to LMCC in the form of interest up to the date of conversion of bonds into equity shares are nothing but interest paid on the money advanced to the applicant... and it is accordingly liable to be taxed as LMCC's income.'

The ruling was sought by an Indian non-banking finance company which had asked the AAR whether the interest paid by it to the US-based LMCC on the bonds issued for funding its business in the country was taxable here. The Indian NBFC, which did not wish to be identified, invests in various businesses in the country and abroad in the form of securities including shares and debentures.

In this case, the company, to fund its business in India, proposed to borrow from LMCC by issuing fully convertible bonds under the foreign direct investment schemes. 'Basically what happens is that the money is advanced to the applicant as a financial package, for which the applicant executes the debenture bonds and till they are converted into shares, the applicant keeps paying interest on the amount covered by bonds. Obviously, the interest is paid in respect of debt. There is no other way of understanding the transaction,' the AAR explained.