Tax on Market-Linked Debentures: Finance Act 2023 makes major changes from 1^st April 2023

Finance Act 2023 inserted a new section 50AA specifically making changes in the taxation of market-linked debentures. Before 31^st March 2023, Market-linked debentures carried two advantages over plain debt instruments:

• These were exempted from withholding tax requirements due to exclusion under Section 193 of the Income Tax Act and
• The holding period in the case of Market-Linked Debentures was taken as 12 months as against 36 months in other cases. Thus, any Market-Linked Debentures sold/ redeemed after a period of 12 months or more were considered as “Long Term Capital Gains” and taxed at the rate of 10% without indexation.

In the case of plain-vanilla debt instruments, an investor is required to pay tax on the annual interest payouts according to his/her applicable slab rates. Whereas in the case of MLDs, the investor was in a position to plan his/her tax slab by reducing the holding period to less than 12 months and thus paying reduced tax at the rate of 10%. This way the MLDs were yielding a better post-tax return to HNIs in comparison to bank fixed deposits & plain vanilla debt instruments like NCDs.

However, The Union Budget 2023 presented by the finance minister has repealed the beneficial tax treatment previously available for MLDs. With effect from 1^st April 2023, a new Section 50AA has been inserted in the Income Tax Act, 1961 with other consequential changes including withholding taxes on MLDs.

What are Market-Linked Debentures?

Market-Linked Debentures are debentures which has an underlying principal component in the form of debt security and where the returns are linked to market returns on other underlying securities. For example, the returns of MLDs may be linked to performance of Nifty.

We have already discussed the tax treatment of MLDs as compared to plain vanilla debt instruments. Even, if we make a comparison of MLDs with derivatives, there was tax discrimination against MLDs. MLDs are like derivatives as these also derive returns on the basis of any underlying asset. In order to eliminate this discrimination, new section 50AA has been inserted

Taxation of Market-Linked Debentures from 1^st April 2023

• Newly inserted section 50AA states that notwithstanding anything contained in Section 2(42A) or Section 48, any gain received or accruing as a result of transfer/ redemption/ maturity of Market-Linked Debentures shall always be taxable as Short-Term Capital Gains.
• Please note that even if the holding period of MLDs is more than 36 months, it will only be classified as a short-term capital asset and therefore it will be subject to tax at applicable slab rates resulting in a higher tax outflow as compared to tax provisions before insertion of section 50AA.
• For calculating the capital gains on MLDs, the cost of acquisition of the MLDs and expenditure incurred wholly and exclusively in connection with such transfer shall be reduced from the full value of consideration received/ accrued.
• STT paid on such debentures shall not be reduced while calculating the capital gains.

It is important to note that the above amendment is applicable with effect from 1^st April 2023 and thus applies for A.Y. 2024-25 and onwards. There are no grandfathering provisions in respect of MLDs acquired before this date. Hence, if any MLDs are acquired before the applicability date i.e. 1^st April 2023, any gains on transfer/ redemption/ maturity of such MLDs will also be hit by this provision.

Will TDS be applicable in the case of Market-Linked Debentures?

Earlier there was no requirement to deduct TDS in the case of MLDs on account of Clause (ix) of the proviso to Section 193 which provided exemption from withholding provisions if the following conditions are fulfilled:

• Any interest payable on any security issued by a company;
• Where such security is in dematerialized form; and
• Is listed on the recognized stock exchange in India.

This clause has been omitted w.e.f. 01-04-2023 and thus payouts in relation to MLDs will be liable for withholding tax with effect from 01-04-2023.

Disclaimer: The above article is meant only for educational purposes and does not carry any persuasive value. Therefore, the readers are advised to act in consultation with any professional before applying the information contained in this article. Taxwink is not responsible for any loss or damage caused to any person on account of any information contained in this article.

About Author: The article is contributed by CA Naveen Goyal who is a qualified Chartered Accountant with an experience of over 16 years in the field of Direct & Indirect Taxes. He is a prolific writer with a zeal to share knowledge on various issues pertaining to taxation laws in India. He can be reached at: support@taxwink.com