Market-linked Debentures Taxation: Before and After 1st April 2023
Till March 2023, MLDs held for over a year and generating capital gains were taxed at a flat rate of 10%. Plus, unlike other debt mutual funds, MLDs did not have a gestation period of 3 years to be categorised as a long-term capital asset. They thus provided better post-tax returns than plain vanilla debt instruments and bank FDs. So, it’s unsurprising that many HNIs considered MLDs desirable for their wealth-building portfolios.
In the Union Budget 2023, presented by Finance Minister (FM) Nirmala Sitharaman on 1st February 2023, the tax treatment previously widely followed for MLDs was repealed. From 1st April 2023 onwards, any revenues (gains) earned from transferring or redeeming MLDs would be classified as short-term capital gains (STCG) and taxed at the rate applicable for the investor (also known as the marginal rate or slab rate) instead of being treated as long-term capital gains (LTCG) and taxed at long term capital gain tax rate of 10%.
Since HNIs fall in the 30% tax bracket, they should expect to be taxed for their MLD gains at this rate (plus a surcharge). Additionally, the tax deducted at source (TDS) exemption that was previously there for all listed Non-convertible debentures (which was applicable for listed MLDs) has now been removed.
Market-linked Debentures: Benefits for Investors After 1st April 2023
Investors must guard against developing a myopic view of MLDs simply because the taxation rules have changed. While it’s true that the scrapping of preferential tax treatment can affect the overall returns possible from MLDs, these new rules also create several positives for investors.
For one, taxing MLDs at the investor’s marginal rate brings much-needed parity between MLDs and other standalone debt instruments like non-convertible debentures (NCDs), bonds, FDs, and G-secs. The interest income from these instruments is also taxed at marginal rates. Such parity can simplify tax planning for investors and give them more visibility into the gains they are earning and the tax they are paying. Further, this means there is no additional negative in MLDs compared to other debt instruments to worry about.
Another positive for investors is that MLDs are now the only debt instrument whose income will always be treated as STCG. And this treatment will be applicable irrespective of the instrument’s holding period and whether the investor decides to sell it in the secondary market or hold it till maturity. If they choose to hold it until the payout date and receive the coupon from the issuer, the proceeds will be taxed as STCG and not as interest under income from other sources (IFOS). Such short-term capital gain is taxed at the same rate as interest and allows one to set off any short-term capital losses carried forward from the last 8 financial years.
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Frequently Asked Questions
What are the key takeaways from this article?
Till March 2023, MLDs held for over a year and generating capital gains were taxed at a flat rate of 10%. Plus, unlike other debt mutual funds, MLDs did not have a gestation period of 3 years to be categorised as a long-term capital asset. They thus provided better post-tax returns than plain vanilla debt instruments and bank FDs. So, it’s unsurprising that many HNIs considered MLDs desirable for their wealth-building portfolios.
Who should read this article?
This article is designed for retail investors, first-time bond buyers, and anyone looking to understand fixed income investments in India.
How does this relate to my investment portfolio?
Understanding these concepts helps you make informed decisions about asset allocation and build a diversified investment portfolio.
