Taxation on Market-Linked Debentures in India
-in-India)
- What are Market-Linked Debentures (MLDs)?
- Market-Linked Debentures Explained: How Do MLDs Work?
- Taxation of Market-Linked Debentures in India: Before & After Budget 2023
- Benefits and Risks Associated With MLDs
- Conclusion
What Are Market-Linked Debentures (MLDs)?
Market-linked Debentures (also MLDs) are a type of debt instrument whose yields are tied up to an underlying market index or benchmark. They have a linkage to the market index, hence known as MLD. This underlying instrument can be the price (or yield) of a government security or any other basket of stocks. Consider them as a hybrid instrument that has no fixed returns but also relies on a market index.
Key Features of MLDs include:
- Tenure: They come with a tenure of 12 to 60 months.
- Coupon rate: Interest payments are not fixed. Instead, returns are receivable at maturity.
- Nature: Although MLDs are non-convertible debentures, they provide yields in par with the market indices.
Market-Linked Debentures Explained: How Do MLDs Work?
Market-linked debentures are debt instruments mimicking the performance of an underlying market index. It is similar to derivatives that are tied to an underlying asset. However, here, the yields depend on the performance of the index. So, for example, if the Sensex 50 is performing well on a particular date, the yield receivable on MLDs will also behave the same.
Let us understand with an example. Suppose ABC is a company that issues market-linked debentures with 15-month maturity. So, considering the MLD does not lose its value (30%) by maturity, you will get the entire 10%. In short, if the Nifty 50 is above 20,000 points, you are eligible for the interest. At this point, if the index does underperform (below 20,000), you will only get the principal amount (initially invested in MLD).
Note: The information, illustrations, and calculations provided in this blog are for general informational purposes only and should not be construed as investment advice or a recommendation.
Taxation of Market-Linked Debentures in India: Before & After Budget 2023
The 2023 budget has changed the taxation of market-linked debentures in India. Initially, Section 2(42A) defined the gains from the listed MLD held for more than 12 months attracted long-term capital gains (LTCG) of 10% plus surcharge. Likewise, for unlisted securities, the standard period for LTCG was 36 months. However, in the case where:
- Long-term capital gains: Any gains arising from an MLD after 12 months but before the maturity period were taxed at 10%.
- Short-term Capital Gains: Gains from MLDs held for 12 months or less were taxed according to the investor's applicable income tax slab rate.
In Budget 2023, the Finance Ministry announced Section 50AA, which brought significant changes to the taxation on MLD. It consisted of:
- Uniform treatment: All gains from MLDs, irrespective of the holding period, are now classified as STCG and taxed at the investor's applicable income tax slab rate.
- Elimination of LTCG: Previously, the benefit of 10% LTCG for MLDs has now been removed.
- Securities Transaction Tax (STT): Such expenses, like STT initially paid by the investor, are not tax-deductible.
- No Grandfather relaxation: As per the section, any market-linked debentures acquired before April 1, 2024, are also subject to new laws.
How To Invest In MLDs?
If you want to invest in market-linked debentures, it is possible through private placements, which are again available to HNIs, UHNIs, and Corporations.
MLDs can be purchased through the issuer's website by completing the Know Your Customer (KYC) process, which includes submitting identification and address proof.
Earlier, the minimum amount for investing in MLDs was ₹10 lakhs. However, the amount has now been lowered to ₹1 lakh to encourage retail participation.
Benefits And Risks Associated With MLDs
With the MLDs, there are certain benefits and risks associated, like:
Benefits of Market-linked Debentures
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Portfolio Diversification:
This basket of MLD comprises various underlying assets, including stocks, indices, and commodities. As a result, there is good diversification that enables chances for higher yields. -
Capital Protection:
Unlike equity instruments, there is always a risk of losing the investment. However, this is not the case for the MLD. Here, you still receive the principal amount back (in some types), thus avoiding any capital erosion. -
Potential for Yields:
Now that these debentures are following the market index, the yield rate is also high. It provides more interest as compared to traditional debt instruments.
Risks of MLDs
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Market risk:
Since the instrument is closely related to the index, poor market performance will affect the MLD investment as well. -
Liquidity risk:
As they come with a maturity date, MLDs are not easily redeemable. Hence, the risk of liquidity brings in challenges when you want to exit early. -
Credit risk:
Technically, MLDs are a source of borrowing for a company. If the company does not perform well, there is an equal chance of losing the initial investment as well. Thus, proper evaluation and analysis of the company are essential. -
Tax Changes:
Following the 2023 amendments, the tax option for holding these debentures for more than 12 months has been eliminated. All gains are now treated as short-term capital gains (STCG) and are taxable at the investor's income slab rate.
Conclusion
Market-linked debentures are a unique blend of fixed-income and market-linked yields. As a result, MLDs have the potential to yield better returns than traditional debt instruments. While they offer multiple benefits, such as capital protection and diversification, they also carry an equal risk of market and liquidity fluctuations. So, whether holding them for a short or long period, it is crucial to consider the taxation on MLD laid out in the 2023 Budget.
Disclaimer: This is for educational/information purposes only. The general topic and information do not aim to influence the investment/trading decisions of any investors.
