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Pranay Bhatia, International Liaison Partner
Partner - Tax & Regulatory Services

28 February 2023

Market Linked Debentures (MLD) are a type of non-convertible debt instrument wherein the returns are determined by the performance of their underlying indexes like Government yield, equity indexes, etc. There is no regular coupon pay-off and the returns are paid at the time of maturity. MLDs are issued for 13 to 60 months by entities having a net worth of at least INR 1000mn. The minimum investment in MLD is INR 100mn. MLDs are a popular instrument for investment among Non-banking Financial Companies (NBFCs) and High Net-worth Individuals (HNIs). In India, the Securities and Exchange Board of India (SEBI) recognises only principal-protected (PP) MLDs, wherein repayment of the principal amount is guaranteed.

Budget proposals

MLDs are hybrid instruments having combined features of plain vanilla debt securities and exchange-traded derivatives. To align the tax treatment of MLD with derivatives, Budget 2023 seeks to insert a new section 50AA in the Act to provide that irrespective of the holding period, gains from MLD shall be taxable as short-term capital gains (STCG) at applicable rates. It is proposed that ‘Market Linked Debentures’ be defined as ‘a security by whatever name called, which has an underlying principal component in the form of debt security and where the returns are linked to the market returns on other underlying securities or indices, and includes any security classified or regulated as a market-linked debenture by the Securities and Exchange Board of India’. Interestingly, on a plain reading of the Budget Memorandum, it seems, that the Government intends to tax gains on listed MLD as STCG. However, in the Finance Bill, there is no such specific mention. Hence, the amendment may be applicable to both listed/unlisted MLD.

Whether taxation of MLD as STCG justified?

Let us analyse the taxation of MLD and each of its components separately:

Plain vanilla debt securities, e.g: bonds: Interest payments on a regular bond are taxable at slab rates as Income from other sources (IFOS). Gains on redemption if any, are taxable as either STCG/LTCG (long-term capital gain) depending upon the holding period.

Derivatives: Transactions in derivatives are invariably short-term transactions and are generally done either for speculation/hedging purposes. The net income from trading in derivatives is taxable at slab rates as business income.


Listed MLD: Return is taxed as LTCG at 10% without indexation/20% with indexation, as per the investor’s choice if the holding period is more than 12 months and at slab rates, if it is less than 12 months.

Unlisted MLD: The taxation is the same as for unlisted debt securities. The return is taxed as LTCG if the holding period is more than 36 months at 10% without indexation for non-residents and 20% with indexation for residents. If the holding period is less than 36 months, STCG is taxed at slab rates.

Based on the above, it is pertinent to note that returns in the form of interest on plain vanilla debt securities and in terms of profit on derivatives, both are taxable at slab rates either as IFOS/business income. Therefore, the returns of MLD should also ideally be taxed at slab rates like that of its individual components (debt + derivatives). Further, in the case of listed MLDs, by increasing the holding period to more than 12 months, the gains were taxable as LTCG at a lower tax rate of 10%. The Government took cognisance of this and hence, brought in deeming provisions to tax the gain on MLD as STCG at slab rates and removed the tax arbitrage.

Impact on Investors

Since the provisions shall be applicable from FY 2023-24 onwards, existing MLDs held for LTCG benefit to be redeemed on or after 1 April 2023, will lead to higher tax outgo (10% to 30% in case of HNIs). Hence, the Government should introduce grandfathering provisions to protect the investments in MLD upto 31 March 2023. In absence of such provisions, investors would now be under a pressure to sell off their investments by 31 March 2023 to tap the existing benefit of a lower tax rate of LTCG. It would also lead to shifting investments into debt mutual funds schemes.

Further, NBFCs may have borrowed money for investing in MLDs. Since the gains shall now be taxable as STCG as against business income earlier, any loss arising on MLD will be deemed as short-term capital loss and will be restricted to set off against STCG/LTCG only. PP MLDs were a great choice due to their principal protection feature and potential for high returns. Due to a lower post-tax return now, MLDs may no longer be viewed as an instrument for tax arbitrage by investors.

Source: Financial Express