Compulsory Convertible Debentures (CCDs): Definition, Legal Treatment, and Practical Use

Key takeaways

• A compulsory convertible debenture (CCD) is a debt instrument that must convert into equity shares at maturity or upon a triggering event, with no option for cash repayment of principal.
• The CCD conversion ratio, fixed at issuance or determined by a price formula, dictates the number of equity shares the holder receives in exchange for the debenture.
• CCDs differ from non-convertible debentures (NCDs), which are repaid in cash and never convert, and from optionally convertible debentures (OCDs), which give the holder a choice between cash repayment and equity conversion. 
• CCDs are treated as equity under FEMA, but as debt under the Income Tax Act until actual conversion.
• Interest paid on CCDs is deductible under Section 36(1)(iii) of the Income Tax Act during the debenture's tenure.

What are compulsory convertible debentures?

A compulsory convertible debenture (CCD) is a debt instrument issued by a company that must be converted into equity shares at a specified time or upon the occurrence of a specified event. Unlike non-convertible debentures, which are repaid in cash at maturity, CCDs carry no obligation of principal repayment. The debenture holder receives equity shares instead.

CCDs are hybrid instruments. They function as debt during their tenure, the holder typically receives periodic interest payments, but they are designed to become equity from the outset. The conversion is mandatory, not optional. This distinguishes CCDs from optionally convertible debentures (OCDs), where the holder can choose between repayment and conversion.

CCDs are widely used in private equity transactions, venture capital bridge rounds, and foreign direct investment (FDI) structures in India. They allow investors to earn a fixed return through interest while deferring equity dilution for the issuing company until a future date.

How compulsory convertible debentures work

A company issues CCDs to investors against a subscription amount. The terms of issuance specify the interest rate (or coupon), the tenure of the debenture, and the conversion terms, including the conversion ratio or conversion price formula. During the tenure, the company pays interest to the debenture holder. At the end of the tenure, or upon a triggering event defined in the agreement, the CCDs automatically convert into equity shares of the company.

The conversion ratio, the number of equity shares each debenture converts into, may be fixed at the time of issuance or determined by a formula linked to the valuation of the company at the time of conversion. This distinction has significant implications for accounting classification, as discussed later in this post.

Key features of compulsory convertible debentures

CCDs share characteristics with both debt and equity instruments:

• The interest component resembles debt: it is a periodic, obligatory cash outflow.
• The mandatory conversion into equity resembles a deferred share issuance.
• CCDs are unsecured. They are not backed by collateral or a charge on the company's assets. 
• The holder does not have voting rights until conversion occurs, and dividends are not payable on CCDs.

Because conversion is compulsory, the company has no obligation to repay the principal in cash. This single feature, the absence of a repayment obligation, is what drives the legal and regulatory classification of CCDs across multiple Indian statutes.

Why companies issue compulsory convertible debentures

CCDs serve distinct purposes for both issuers and investors.

a. For the issuing company, CCDs defer equity dilution. A company that issues CCDs does not immediately increase its share count, which means existing shareholders retain their ownership percentages for the duration of the debenture tenure. The company also benefits from the tax deductibility of interest paid on CCDs during their tenure.

b. For investors, particularly private equity funds and venture capital firms, CCDs offer downside protection through periodic interest payments while preserving the upside of eventual equity ownership. When the CCD converts into equity as per the agreed terms, the investor participates in the company’s appreciation. CCDs are also preferable to preference shares in some structures because interest on CCDs is tax-deductible for the issuer, while dividends on preference shares are not.

c. CCDs are also used as bridge financing instruments. When a company needs capital between funding rounds but does not want to negotiate a new valuation immediately, they can provide interim funding. When structured with a conversion formula linked to the next funding round, they defer the final share price determination to that round. This is conceptually similar to how convertible notes function in early-stage fundraising, though CCDs carry a mandatory conversion feature that convertible notes typically do not.

How compulsory convertible debentures are treated under Indian law

Compulsory convertible debentures under Companies Act, 2013

Section 2(30) of the Companies Act, 2013, defines a debenture to include "debenture stock, bonds or any other instrument of a company evidencing a debt." CCDs fall within this definition. Section 71, read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, authorizes companies to issue debentures with an option to convert into shares, subject to approval by special resolution.

Under the Companies Act, CCDs are regulated as debentures. The company must comply with debenture issuance procedures, including board and shareholder approvals, and must make appropriate disclosures in financial statements under Schedule III regarding the rate of interest and particulars of conversion.

Compulsory convertible debentures under FEMA and FDI regulations

Under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, CCDs are classified as capital instruments — on par with equity shares. Regulation 2(v) defines capital instruments to include "equity shares, debentures, preference shares and share warrants issued by an Indian company," with the clarification that "debentures" means "fully, compulsorily and mandatorily convertible debentures."

This classification has a direct practical consequence. When a non-resident investor subscribes to CCDs of an Indian company, the investment is treated as FDI, not as external commercial borrowing (ECB). The FDI route permits investment subject to sectoral caps and pricing guidelines. Optionally convertible debentures and partially convertible debentures, by contrast, do not qualify as capital instruments and must comply with ECB norms instead.

Compulsory convertible debentures under SEBI regulations

Under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations), convertible debentures, including both optionally convertible and compulsorily convertible instruments, are treated as “specified securities” alongside equity shares.

Note: The term specified securities under the ICDR framework refers to equity shares and securities that are convertible into equity shares. In other words, SEBI groups CCDs and other convertible instruments with equity because they ultimately result in equity share capital of the listed company.

The ICDR Regulations also regulate “preferential issues,” which refer to the allotment of specified securities by a listed company to a select group of identified investors rather than through a public offering. Under Regulation 158, SEBI has the power to grant exemptions from certain preferential issue requirements for specified securities. This includes both equity shares and CCDs.

Additionally, for certain public offer eligibility conditions under the ICDR Regulations, such as the minimum holding period requirement for equity shares proposed to be offered in an IPO, the period for which CCDs were held prior to conversion may be aggregated with the holding period of the resulting equity shares when calculating the required holding period.

Income tax treatment of compulsory convertible debentures

The income tax act, 1961, treats CCDs as debt instruments until the date of actual conversion. 

Interest deductibility under Section 36(1)(iii)

Section 36(1)(iii) allows a deduction for interest paid on capital borrowed for business purposes. The question is whether CCDs constitute "capital borrowed."

The Bangalore ITAT in CAE Flight Training (India) (P) Ltd. v. Dy. CIT  held that interest paid on CCDs is deductible under Section 36(1)(iii) until the date of conversion. The Tribunal rejected the revenue's argument that CCDs should be treated as equity for income tax purposes merely because FEMA treats them as equity. The Tribunal reasoned that RBI's FDI policy classifies CCDs as equity for foreign exchange management purposes, specifically to address repatriation obligations, and this classification does not override the Income Tax Act's treatment of interest on borrowed capital.

The Delhi ITAT in Religare Finvest Ltd. v. DCIT  reached the same conclusion: CCDs are borrowed funds until conversion, and interest paid on them is an allowable expenditure.

Deductibility of issuance costs

Whether expenses incurred in issuing CCDs are deductible is a separate question. The Ahmedabad ITAT in Ashima Syntex v. Asstt. CIT (2006) held that because CCDs are not borrowings — since there is no obligation to repay — the issuance expenses were not deductible. 

However, the Rajasthan High Court in CIT v. Secure Meters Ltd. (2008) held that expenses on issuance of convertible debentures are deductible. The Supreme Court dismissed a Special Leave Petition against this ruling, making it the more authoritative position. Issuance costs of CCDs are generally considered deductible.

Capital gains on conversion — Section 47(x)

Section 47(x) of the Income Tax Act provides that the conversion of bonds or debentures into shares of the same company is not treated as a "transfer" for capital gains purposes. No capital gains tax liability arises on conversion of CCDs into equity shares of the issuing company. 

Thin capitalisation rules — Section 94B

Section 94B limits the deduction of interest expense on debt to associated enterprises. For this purpose, "debt" is defined broadly to include any loan, financial instrument, or arrangement giving rise to deductible interest, discounts, or finance charges. CCDs, during their tenure as debt instruments, fall within this definition. Interest on CCDs issued to associated enterprises would be subject to the thin capitalisation cap (deduction is limited to 30% of EBITDA or the actual interest paid, whichever is lower).

GAAR implications

Sections 95 to 102 of the Income Tax Act establish the General Anti-Avoidance Rules (GAAR). Under GAAR, if the principal purpose of an arrangement is to obtain a tax benefit through misuse of the Act's provisions, the tax authority can re-characterize the arrangement. Section 98(2) specifically provides that equity may be treated as debt or vice versa. If CCDs are issued primarily to claim interest deductions, without genuine commercial substance, the tax authority may invoke GAAR to treat the CCDs as equity, disallowing the interest deduction.

Accounting treatment of compulsory convertible debentures under Ind AS 32

The accounting classification of CCDs under Indian Accounting Standards (Ind AS) depends on the substance of the contractual arrangement, not its legal form. Ind AS 32, Financial Instruments: Presentation, establishes the principles for classifying financial instruments as liabilities or equity.

1. Fixed vs variable conversion ratio

The critical question is whether the CCD converts into a fixed number of equity shares or a variable number.

If the CCD converts into a fixed number of shares, for example, 1,000 CCDs converting into 10,000 equity shares regardless of the share price at the time of conversion, the instrument satisfies the "fixed-for-fixed" test under Ind AS 32. The conversion component qualifies as equity from inception.

If the CCD converts into a variable number of shares, for example, at the prevailing market price, meaning the number of shares depends on future valuations, the instrument does not satisfy the fixed-for-fixed test. The conversion component is classified as a financial liability.

2. Compound instrument classification

When a CCD has mandatory interest payments and converts into a fixed number of shares, it is classified as a compound financial instrument. The issuer must bifurcate the instrument into two components: a financial liability (the obligation to pay interest) and an equity component (the conversion into a fixed number of shares). 

The liability component is measured first at fair value, determined by reference to the fair value of a similar standalone debt instrument, and the equity component is the residual amount.

When a CCD has mandatory interest payments and converts into a variable number of shares, both components are financial liabilities. There is no equity component to recognize.

The ICAI's Expert Advisory Committee (EAC) confirmed this analysis in its opinion on CCD classification, noting that an instrument qualifying as equity for regulatory purposes may still be classified as a financial liability under Ind AS if the substance of the contractual terms requires it.

3. EPS implications

Under Ind AS 33, Earnings Per Share, the classification affects how CCDs are treated in EPS calculations. If the CCD is classified as equity under Ind AS 32, the underlying shares are included directly in the calculation of basic EPS. If classified as a liability, the potential conversion into equity shares creates dilutive potential ordinary shares, requiring separate disclosure of diluted EPS.

CCD vs NCD vs OCD: Key differences

Compulsory Convertible Debentures (CCDs), Non-Convertible Debentures (NCDs), and Optionally Convertible Debentures (OCDs) are all debenture types under the Companies Act, but they differ in fundamental ways.

How compulsory convertible debentures affect your cap table

CCDs have a direct impact on a company's cap table, even before conversion occurs.

Before conversion, CCDs appear as convertible instruments on the cap table. They represent potential future dilution that must be accounted for when modeling fully diluted share counts. Any cap table analysis that ignores outstanding CCDs will understate the potential dilution to existing shareholders.

The conversion terms determine the magnitude of dilution. A CCD with a fixed conversion price that is lower than the company's current fair value will convert into more shares and cause greater dilution. A CCD with a conversion price tied to a future valuation round creates uncertainty in dilution modeling (the actual dilution depends on the price at which the next round is priced).

When conversion occurs, the CCDs are extinguished and replaced by equity shares on the cap table. The number of shares issued, the resulting ownership percentages, and the updated fully diluted capitalization must all be recorded accurately.

Companies managing CCDs alongside other convertible instruments, such as SAFEs and convertible notes, need structured systems to track conversion terms, model dilution scenarios, and maintain accurate records for investor reporting and compliance. 

EquityList allows companies to record CCD issuances, track conversion terms, and model the dilution impact of pending conversions, keeping the cap table audit-ready without relying on parallel spreadsheets. Book a demo.

FAQs

1. Is CCD a debt or equity?

The classification of a CCD as debt or equity depends on the legal framework being applied. Under FEMA (Foreign Exchange Management Act), CCDs are treated as equity instruments because they do not contemplate repayment of the principal.

Under the Income Tax Act, CCDs are treated as debt until actual conversion, allowing interest deductibility under Section 36(1)(iii). Under Ind AS 32, the classification depends on whether the conversion ratio is fixed or variable. A fixed ratio classifies the conversion component as equity, while a variable ratio classifies it as a financial liability.

2. What is the difference between CCD and NCD?

A compulsory convertible debenture (CCD) must be converted into equity shares at maturity, and the holder cannot receive cash repayment. A non-convertible debenture (NCD) is repaid entirely in cash at maturity and never converts into equity.