Market-linked Debentures Hit below the Belt!

Ranganathan V 02 February 2023

Investor Interest

Market-linked debentures (MLD) have been around for some time now and their unique structure, where the coupon is not a fixed rate like common debentures but linked to certain events with some marginal uncertainty, helped qualify them as a different class of asset for tax purposes.

A typical debenture or a corporate bond is akin to a normal deposit in a bank or a company and the interest paid periodically is taxed as regular income and also subject to deduction of tax at source.

However, MLD with its inherent structure, where no ostensible coupon exists, was being viewed like a capital asset and the profit or gain on the sale or redemption was qualified as a capital gain.

MLD issues, typically, get listed in the debt section of BSE and the tax rule, which treats all listed securities held for more than 12 months as a long-term asset, applies to this as well. Thus, a class of asset or investment not dissimilar to a corporate bond was getting a favourable tax dispensation, as long-term capital gain on listed securities attracts a much lower tax at 10% plus applicable levies as compared to interest income attracting the scheduled rates.

This arbitrage needed to be corrected and the Budget announcement has brought in a change. MLD, after 1 April 2024 assessment year (2023-24 previous year), will be treated as a short-term capital asset irrespective of its structure.

No legitimate grievance can be raised on the change as, in fact, the short-term classification is generous in itself as tax payers who get a surplus on the transfer of an MLD can adjust short-term capital loss on any other asset. Interest on normal debt issues doesn’t enjoy this benefit.

The legitimate grievance is, however, that MLD currently in issue are also affected when sold or redeemed after 1 April 2023. This date is not too far off and investors who hold such issues, with a holding period of more than 12 months, will rush to sell in the next 60 days, to lock into long-term capital gain tax. This will push up the yields and depress the prices unduly.

Many may resort to make-believe transactions with relatives or friends only to buy back after a few days! The brokers may cheer with commission income unbudgeted!

The reasonable dispensation should be shelter or grandfather debentures already issued and bought by investors before 1 February 2023. In the absence of this, investors, who legitimately factored the tax rate in the investment decision, would be unfairly hit by this move.

This government has vowed not to amend laws retrospectively to the detriment of taxpayers and has lived up to that promise so far. Why do damage to this image in an election-year Budget though not many MLD investors may vote?

(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)

Comments

User

Kamal Garg

3 years ago

Do you mean to say that MLD has been and will remain classified as "capital asset". The only change is that MLD will be classified as "short term capital asset" and that no further change has been put in the Finance Bill 2023. This means that MLD will still be classified as "equity/equity oriented" capital asset and therefore would attract a tax rate of 15% for short term capital gain. And further that this short term capital gain/loss would be adjustable against other such short term capital gains.
For the understanding of your readers, it is requested to kindly give a few examples of such MLD as issued and listed/traded on stock exchange so that complete understanding can be there.