Understanding the taxation rules of Market-Linked Debentures (MLDs)

In contrast to traditional fixed-income securities, market-linked investments offer the potential for higher returns. However, higher return potential may also mean higher taxes. Understanding the tax implications of the investment you choose is essential for optimising post-tax returns. This article explains Market-Linked Debentures (MLDs), a type of market-linked debt instrument, and the impact of Section 50AA of the Income Tax Act on their taxation.

What are MLDs? 

Debentures are debt securities issued by companies to raise capital. Traditionally, debentures are fixed-income investments that offer regular, predetermined interest payments and return the principal amount at maturity. 

Market-linked debentures are a specialised form of debentures where the returns are linked to the performance of an underlying index, such as the NIFTY 50 or Sensex, instead of offering a fixed coupon. These usually come with a maturity period ranging from 1-5 years. 

MLDs are of two types: principal-protected MLDs and non-principal-protected MLDs. As per the Securities and Exchange Board of India (SEBI) regulations, only principal-protected MLDs are permitted for retail investors. 

Decoding Section 50AA of the Income Tax Act

Section 50AA of the Income Tax Act governs the taxation of capital gains arising from MLDs and special mutual funds. This provision was introduced in the Finance Act, 2023.

Earlier, the taxation of MLDs depended on the holding period. 

• Gains on MLDs held for up to 12 months were treated as short-term capital gains and taxed at the applicable slab rate.
• Gains on MLDs held for more than 12 months were treated as long-term capital gains and taxed at 10% (without indexation) plus applicable surcharge.

Thus, MLDs were partially placed on par with equities for the purpose of taxation, creating a tax arbitrage opportunity.

To end this arbitrage, Section 50AA mandates that all gains from MLDs, whether arising from transfer, redemption, or maturity, are treated as short-term capital gains, irrespective of the holding period. These gains are added to the investor’s total taxable income and taxed as per the applicable income tax slab rate. 

This amendment aligns the taxation of MLDs with other debt instruments, ensuring consistency and fairness. 

Calculating capital gains under Section 50AA: An example

Here’s an example to understand how capital gains are calculated and taxed under Section 50AA:

Investment amount: ₹10 lakh 

Holding period: More than 12 months 

Maturity amount: ₹15 lakh

Capital gains: ₹5 lakh 

If you fall under the highest tax slab of 30%, the entire ₹5 lakh will be taxed at 30% plus applicable cess. Earlier, the entire capital gain would have been subject to 10% tax rate. Thus, under Section 50AA, the tax outgo is significantly higher, directly impacting post-tax returns. 

Why m.Stock is the right platform for debt investors

Choosing the right platform is important for a smooth investment experience. Here’s what makes m.Stock stand out: 

• Zero brokerage or subscription charges with no hidden fees, ensuring cost transparency
• Access a wide range of debt instruments on a single platform including through mutual funds and ETFs
• Goal-oriented investment options, supporting both lump sum and Systematic Investment Plans (SIPs)
• A user-friendly platform with seamless digital onboarding 

Conclusion

MLDs were once popular for their favourable tax treatment. Section 50AA of the Income Tax Act has ended the tax arbitrage, bringing MLD taxation in line with other debt instruments.