Tax Hotline: Tax tribunal holds conversion of OCCRPS into equity does not trigger taxation under section 56(2)(x)

Tax tribunal holds conversion of OCCRPS into equity does not trigger taxation under section 56(2)(x)

In a significant ruling for the taxation of hybrid securities, a Mumbai Bench of the Income Tax Appellate Tribunal (“Tribunal”) has held that the conversion of optionally convertible cumulative redeemable preference shares (“OCCRPS”) into equity shares does not result in a taxable receipt under section 56(2)(x) of the Income-tax Act, 1961 (“ITA”). The decision in Fairbridge Capital (Mauritius) Limited v. Ass’t Comm’r of Income Tax¹ decisively rejects the Revenue’s attempt to tax the differential between the fair market value of equity shares at the time of conversion and the pre-agreed conversion price as “income from other sources”.

Background

In April 2021, the taxpayer, a Mauritius-resident company, subscribed to OCCRPS of Thomas Cook (India) Limited (“TCIL”), a listed Indian company, pursuant to a preferential issue. In compliance with the Securities and Exchange Board of India (“SEBI”)’s Issue of Capital and Disclosure (“ICDR”) Regulations, the conversion price was fixed upfront at INR 47.30 per equity share, based on the prevailing market price at the time of issuance.

The OCCRPS were converted in March 2022. Scrutiny proceedings were initiated against the taxpayer in May 2023. The Assessing Officer (“AO”) determined the fair market value (“FMV”) of the equity shares under Rule 11UA at the time of conversion to be INR 66.15 per share and sought to tax the difference between the conversion price and the FMV under section 56(2)(x).² The addition was confirmed by the Dispute Resolution Panel (“DRP”) and a final assessment order was issued.

The taxpayer appealed to the Tribunal.

Tribunal’s decision

The Tribunal allowed the appeal and set aside the addition in its entirety.

It emphasised that section 56(2)(x) is a deeming provision with a limited anti-abuse objective: to bring to tax certain receipts of property where “there is a clear element of gratuitous enrichment or colourable value shifting, camouflaged as a transaction”. Its application cannot be stretched to embrace “mere conversions or exchanges where property is surrendered for property received, both being valued on a comparable plane and at the relevant point of time.”

The Tribunal held that the Revenue’s approach was founded on a fundamental conceptual error in equating the pre-determined conversion price with “consideration” for purposes of section 56(2)(x). The conversion price, the Tribunal observed, “is not the price paid on the date of conversion, nor does it represent the economic value parted with by the assessee at that stage.” The consideration for receipt of equity shares is the surrender of the OCCRPS themselves, which are capital instruments of a derivative character whose value is intrinsically linked to the value of the underlying equity shares. Consequently, the correct comparison under section 56(2)(x) is between the aggregate fair market value of the equity shares received and the aggregate value of the OCCRPS surrendered at the time of conversion. When viewed on this contemporaneous and aggregate basis, there is no inadequacy of consideration.

The Tribunal further held that the Revenue’s analysis improperly collapsed the distinction between “consideration” and “cost of acquisition”. The conversion price, by virtue of section 49(2AE), determines the cost of acquisition of the equity shares for future capital gains computation.³ It does not, however, represent the consideration for which the equity shares are received on conversion. By treating the conversion price as consideration under section 56(2)(x), what the Revenue effectively sought to tax was the accretion in value of the preference shares between issuance and conversion. Such appreciation represented an accretion in capital, and, under the ITA, its realization was deliberately rendered tax-neutral at the stage of conversion, with taxation deferred until a subsequent transfer of the resulting equity shares.

The ITAT also rejected the Revenue’s reliance on Rule 11UA⁴, reiterating that valuation rules are machinery provisions that cannot create or expand a charge of tax. Rule 11UA cannot be invoked to artificially manufacture an inadequacy of consideration by comparing fair market value with a historical conversion benchmark that does not represent consideration in law.

Analysis

The Tribunal’s ruling restores conceptual discipline to the application of section 56(2)(x) in the context of convertible instruments. At its core, the decision reinforces that section 56(2)(x) is a narrowly targeted anti-abuse rule aimed at taxing gratuitous receipts or disguised value transfers. Its invocation necessarily depends on the existence of a real inadequacy of consideration at the time of receipt, assessed in economic and commercial terms.

By rejecting the Revenue’s attempt to treat the pre-determined conversion price as “consideration”, the Tribunal correctly aligned the application of section 56(2)(x) with the broader statutory scheme, which insofar as convertible instruments held as capital assets are concerned, is clear: their conversion is intended to be a non-taxable event, with any appreciation in value taxed only at the time of transfer of the resulting security. In this context, taxing the difference between the pre-determined conversion price and the value of the equity shares received on conversion would interfere with this scheme by effectively taxing capital appreciation as ordinary income at the conversion stage, which the ITA expressly seeks to avoid.

The decision also underscores an important economic principle: a convertible instrument, at the point of conversion, is worth what it converts into. Because the value of the OCCRPS is intrinsically linked to, and derives from, the underlying equity shares, there is no economic shortfall or surplus when the preference shares are surrendered for equity on conversion. When both sides of the exchange are valued contemporaneously and on the same footing, the premise of “inadequate consideration” necessarily fails. This approach is consistent with the Supreme Court’s reasoning in Reva Investment v CGT⁵, that in exchange transactions, adequacy of consideration must be assessed in a broad commercial sense rather than by reference to historical prices.

Conclusion

Issues around the tax treatment of conversion of convertible or hybrid capital instruments, including pursuant to the triggering of anti-dilution adjustments and liquidation preference rights, routinely arise in private equity and M&A transactions. Against this backdrop, the ruling provides welcome clarity for private equity and structured investment transactions involving convertible or hybrid capital instruments, including compulsorily convertible preference shares (CCPS), compulsorily convertible debentures (CCDs), and optionally convertible debentures (OCDs). It reaffirms that appreciation embedded in such instruments remains within the capital field, with the statutory scheme deliberately deferring taxation until the transfer of the resulting security, rather than accelerating or recharacterizing such appreciation at the stage of conversion.

The decision should therefore offer support in pending and future assessments involving CCPS, CCDs, OCDs and similar hybrid instruments, where the Revenue has sought to apply section 56(2)(x) to conversion transactions.

Joachim Saldanha
You can direct your queries or comments to the author.

¹ITA No.1626/Mum/2025

²Section 56(2)(x) of the ITA is a deeming provision that brings to tax certain receipts of money or property where such receipt is without consideration or for inadequate consideration. Broadly, where a person receives specified property (including shares and securities) and the fair market value of such property exceeds the consideration paid by more than the prescribed threshold, the excess is deemed to be “income from other sources” in the hands of the recipient.

³Under the scheme of the ITA, gains arising on the transfer of a capital asset are taxed as capital gains. Section 47(xb) provides that the conversion of preference shares into equity shares is not a taxable transfer, so any increase in value up to the date of conversion is not taxed at that stage. Section 49(2AE) then ensures that this untaxed appreciation is carried forward by linking the cost of the equity shares to the cost of the preference shares, so that the appreciation is taxed later when the equity shares are sold.

⁴Rule 11UA of the Income-tax Rules, 1962 is a valuation rule that prescribes the method for determining the fair market value of specified assets, including unquoted shares and securities, for the limited purpose of applying certain deeming provisions under the ITA, such as section 56(2)(x).

⁵249 ITR 337