Active Stocks
Thu Mar 28 2024 15:59:33
  1. Tata Steel share price
  2. 155.90 2.00%
  1. ICICI Bank share price
  2. 1,095.75 1.08%
  1. HDFC Bank share price
  2. 1,448.20 0.52%
  1. ITC share price
  2. 428.55 0.13%
  1. Power Grid Corporation Of India share price
  2. 277.05 2.21%
Business News/ Money / Personal Finance/  Why market-linked debentures need to have grandfathering relaxation
BackBack

Why market-linked debentures need to have grandfathering relaxation

For a risk averse investor who wants to invest in a debt security but with a return linked to the market, the market-linked debenture (MLD) perfectly fits the bill

istockPremium
istock

For a risk averse investor who wants to invest in a debt security but with a return linked to the market, the market-linked debenture (MLD) perfectly fits the bill.

MLDs are debt instruments, regulated by the Securities and Exchange Board of India (Sebi), and are usually listed. MLDs returns are linked to the performance of an underlying index or security in the market. Before the budget announcement, MLDs were becoming popular investment avenues. As listed securities, these instruments enjoyed a lesser holding period of 12 months for determining capital gains, vis-à-vis the longer holding period of 36 months, applicable in case of unlisted securities.

The gain arising on transfer of a listed MLD after a period of one year, but before its maturity, uptill 31 March, is being considered as long-term capital gain (LTCG), and is subject to the concessional tax rate of 10% plus applicable surcharge. However, in case of MLDs kept till maturity, the interest income is taxable in the hands of the investor just like any other interest income at the applicable slab rate of the investor. By virtue of clause (ix) of proviso to Section 193 of the Income Tax Act, any interest income arising on a listed MLD, is currently exempt from the requirement of deduction of TDS (tax deducted at source).

The budget has proposed that any gain arising on transfer of an MLD, on or after 1 April, will be considered as a short-term capital gain (STCG), irrespective of the period of its holding, and will be taxable at the applicable slab rate of the investor and not as long-term capital gain at a reduced tax rate of 10%.

As the investors of MLDs are usually high net-worth individuals (HNIs) or corporates, the effective tax rate on any gain arising on transfer of an MLD, on or after 1 April, will be 30% or 22% or 15% plus applicable surcharge, depending upon the choice of taxation regime. Any gain arising on transactions in exchange traded derivatives (F&O) is taxable as business income at the applicable slab rate of the investor. The rationale, as provided in the explanatory memorandum, for treating any gain on the transfer of an MLD as a STCG and taxing it at the higher rate based on the slab rate of the investor is that an MLD differs from a plain vanilla debt security and is a hybrid instrument combining features of both plain vanilla debt security and an exchange traded derivative and as such should be taxable at the applicable slab rate of the investor, just like the business income.

Starting April, the exemption available in respect of tax deduction at source on interest income earned on listed debt securities, has also been discontinued because the budget has fixed a 10% TDS on listed company bonds. But since any gain on transfer/redemption/maturity of MLDs will be taxed as STCG, and TDS is usually not deducted on such gain, the tax department should come up with a suitable clarification in this regard.

It is imperative to note here that such tax treatment of considering the transfer of an MLD as STCG, in all cases, and taxing the same at applicable slab rate of the investor, has been made applicable, even for existing MLDs, lying in the portfolio of investors and acquired before 1 April, and no grandfathering relaxation has been proposed in the Finance Bill 2023. The grandfather clause is defined as part of a new rule or law that does not apply to a particular group of people, allowing them to continue following the old rule or law.

The absence of grandfathering protection may result in creating liquidity issues in the bond market segment as the existing investors will ask for their premature redemption, in order to ensure that the specified deadline of 1 April is not breached. Any retrospective/retroactive amendment is usually not seen in good light by the judiciary and as such this budget amendment is definitely amenable to be challenged before the appropriate appellate forums.

The government should consider providing the much-needed grandfathering relaxation in respect of MLDs, acquired before 1 April, and lying in the investment portfolios of investors, just as it was provided at the time of making long term capital gain on listed equity shares in excess of 1 lakh, taxable by the Finance Act 2018. Clarity is also required on the method to be adopted i.e., FIFO (first in, first out) or weighted average method, for determining the date of transfer and cost of acquisition of an MLD, for the purpose of its STCG computation.

Mayank Mohanka is the founder of TaxAaram India, and a partner at S M Mohanka & Associates

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 28 Feb 2023, 11:26 PM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App