Tax & Exit Implications of Structured Products

Introduction

Market-linked debentures (MLDs) and Structured Products (SPs) have gained immense traction in recent years. A customized debt security with a linkage to equity or other asset classes has made them quite favorable among investors. With time, this combined market plans to expand at ₹6000-₹7000 crore annually.

But, as an investor, when you invest in a structured product, what tax implications apply to you? Also, can you exit at any time, or is liquidity limited?

To find the answers, keep reading as we decode the taxation for structured products and their exit implications.

Also, understand the difference between MLDs and structured products and why other nations call them synonymously.

What Are Structured Products, and How Do They Differ from MLDs?

Structured Products are hybrid financial instruments that bring two or more asset classes into one. It typically includes a fixed-income component (like debt) with a market-linked component (such as equity, commodity, or currency derivatives) as an underlying instrument.

But what's the need for an underlying asset?

Well, that's what gives structured products their edge.

The underlying asset determines how returns are calculated, allowing investors to enjoy the stability of debt while experiencing the taste of market-linked growth.

For instance, Market-Linked Debenture (MLD) may include an NCD whose returns are linked to an underlying benchmark like the Equity Index or the 10-year G-Sec yield.

Are Structured Products And MLD the Same?

In simple terms, they're almost the same, but the difference lies in their structure and how they are referred to in different markets.

Globally, Structured Products (also known as Structured Notes) are customized investments that combine debt and derivatives. They are usually offered over the counter (OTC) by financial institutions.

In India, these same products are issued in the form of debentures. Therefore, they are known as Market-Linked Debentures (MLDs) – a more accurate term to describe the linkage between debentures and the market.

So, while the concept and purpose remain the same, the name and legal structure differ due to regulatory requirements and market practices.

Taxation of Structured Products in India

In India, MLDs and Structured products are taxed in the same manner. All gains from structured products are treated as Short-Term Capital Gains (STCG) and taxed at the investor's applicable income tax slab rate, irrespective of the holding period.

So, even if you held for more than a year, it will still be treated as STCG.

The same was not applicable before. Earlier (before FY 2023), MLDs held for more than 12 months attracted a 10% Long-Term Capital Gains (LTCG) tax. However, the Union Budget 2023 removed this benefit, eliminating LTCG treatment for MLDs and other structured products.

Additionally, no deductions are allowed for expenses such as Securities Transaction Tax (STT) and similar charges while calculating taxable gains.

Exit & Liquidity Implications of Structured Products

It is important to understand that structured products have limited liquidity in the market. It means, as an investor, you cannot easily sell them in the secondary market (or on exchanges). So, are structured products closed-ended?

Well, the Lock-in period is the lead. As these products have a lock-in (of an average of 12 months) to serve, investors can redeem their SP investments later, but not in the secondary market. It is because finding a buyer at a fair price before maturity is rare, even when some MLDs are listed on exchanges.

Instead, such transactions can occur in the offline market, and the MLD holder receives a delivery instruction slip in return. But this deal again depends on the issuer. In case early exit is allowed (by the issuer), you will receive lower returns compared to the mentioned SP rates.

So, is there a fixed investment horizon for SPs?

These products have a predefined return, where the potential is fully unlocked upon maturity. Early exit will reduce the cumulative returns achievable. Hence, investors should treat SPs as medium to long-term investments, only if they can stay committed till maturity.

Example of Structured Product

Suppose you invest ₹10 lakh in a 3-year Structured Product linked to the NIFTY 50 index.

• If NIFTY goes up by the end of 3 years, you earn a 10% annual return.
• If NIFTY stays flat, you get back your ₹10 lakh (principal amount).
• Similarly, if NIFTY falls below a defined level, the yield start to decay.

So, technically, your money is protected, but your proceeds depend on how NIFTY performs. That's why it's called a Market-Linked Debenture (MLD), as it combines the safety of debt with market-linked returns.

Conclusion

In India, MLDs and Structured Products have seen a wave of new investors investing in them. However, with these investments, it is necessary to look at the tax rules that apply to them. Irrespective of the holding period, STCG applies to your respective slab rates. But this rule would still follow despite the exit period. So, even if you redeem after a year or on maturity, the exit implications do imply.