Market Linked Debentures- Why Will They No Longer be Attractive for HNIs?

The recently announced Union Budget 2023 came with a mixed bag of tax benefits for some and tax disadvantages for few others. In a major blow to HNIs, the budget announced taxation changes to market-linked debentures (MLDs), eliminating the tax advantage enjoyed by these investments. Previously, MLDs were a popular investment choice among high net-worth investors due to the favorable tax treatment of only 10% if held for over 12 months. 

So, what changes for HNIs, will MLDs lose their shine? 

In this blog, we will explore the impact of taxation changes on MLDs and whether they will continue featuring in HNI investment portfolios post Apr 1, 2023.

What are MLDs and how do they work?

Market Linked Debentures (MLDs) are a type of investment where the returns are tied to the performance of a specific market index, like the Nifty 50 or even securities like government bond yields. Instead of having a fixed return like regular bonds, MLDs offer returns based on the performance of the chosen market index or underlying security. 

But, what makes MLDs unique?

• Minimum investment amount is Rs. 25 lakhs, which means it’s ideal for HNIs
• These SEBI-regulated investments usually have a length of 1 to 5 years, meaning, they do not usually pay out regularly and only return money at the end of the investment period
• They can be listed or unlisted, and secured or unsecured.
• Since they are rated by Credit Rating Agencies, investors know whether they are worth considering
• Until recently, MLDs have been largely used as a means to gain tax advantage, resulting in higher post-tax return for HNIs compared to fixed income instruments

Did you know

Some of the large financial companies that offer market-linked debentures in India include Reliance Capital, Kotak Mahindra Investment, L&T Infrastructure Finance Company, Axis Finance and Motilal Oswal Home Finance.

Example of how MLDs work

Let’s suppose you invest in an MLD offered by ABC company. This investment will pay you 8% a year and will end in 15 months. But, you’ll only get that 8% if a government bond (maturing in 2030) DOES NOT LOSE 25% of its value by the 14th month. If the government bond DOES LOSE that much in terms of its price value, you’ll only get your original investment back, but no interest income.

This format is also known as Principal Protected MLD as it gives the investor his/her original investment back. In the above example, the 8% returns are linked to the government bond.

So, is it a win-win?

ABC company benefits with the borrowed money at 8% rate which is better than other borrowing rates. For you, the investor, the 8% is actually 7.2% if considered post-tax because if you hold the MLD for more than a year, the tax rate will be 10%. If you sell the MLD before it matures, the 8% is taxed just like a fixed deposit. Therefore, it makes sense to wait until maturity to avoid paying more tax. 

Before you jump towards investing in MLDs – This tax rule has changed! To find out how, read further.

After Budget 2023, no more preferential taxation on MLDs

Budget 2023 has essentially changed the way income from Market-linked Debentures will be taxed. 

• Before Budget 2023, if you held these debentures for more than a year, you paid a 10% tax on any profits.
• After Budget 2023, the tax will be based on your income tax bracket, which can be as high as 30%.

Starting from the new financial year in April 2023, MLD returns will be considered as short-term capital gains, just like with other bond investments.

To put it simply, instead of being taxed like stocks, they will now be taxed like bonds. Also, you should know that the tax change also applies to MLDs held today and are sold or mature after 1 April 2023. Therefore, it may be beneficial to sell these MLDs immediately if you are looking to get the tax benefit.

Conclusion

To conclude, tax changes on MLDs will hit HNIs and family offices first. As returns from MLDs will be considered as short-term capital gains, these investors will look for alternative avenues such as mutual funds. In case of mutual funds, investors can continue to avail the long-term capital gains tax advantage with indexation benefit. This will result in MLDs losing their shine over a period.  

FAQs

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