High net worth individuals can give up market linked debentures

Any debt instrument held for less than 36 months attracts short-term capital gain (STCG) tax, unlike MLD, wherein such gains are taxed at the income tax slab rate of the investor. In case of HNIs, it can be 30%- the highest tax slab-rate.

Till now, MLDs enjoyed tax treatment similar to equity security, even though these behave like debt instruments. These were taxed at only 10% if held for more than 12 months, which is the required holding period for equity gains to be eligible for long-term capital gains (LTCG) tax. Hence, HNIs looking for debt instruments prefer investing in MLDs.

What has changed now?

The Budget proposals effectively mean that MLDs will attract STCG regardless of the holding period and will be taxed at the investor’s tax-slab rate, which can be as high as 30% in the case of HNIs.

The budget also proposes to define MLD as a security which has an underlying principal component in the form of a debt security and the returns are linked to market returns on other underlying securities or indices.

The changes applicable to MLDs make them much less attractive to HNIs (those in the highest income-tax-slab rate), who chose these products for higher post-tax returns.

Earlier, an MLD from a Double A-minus issuer would offer a post-tax yield of 9% (considering LTCG tax rate of 10%). Now, assuming the highest income-tax-slab rate of 30%, the post-tax returns would come down to 7.2% for the same holding period.

Let us take an example. Suppose you invest 10 lakh with a maturity of 36 months in MLD. You will not only get your principal back 10 lakhs, but also additional coupon payment at the time of maturity. this amount will be 13.31 lakhs after three years, which will translate into capital gain 3.31 lakhs. after tax, it will come down to 2.97 lakh (LTCG tax rate of 10%; tax liability of 33,100). Such profit will now come down to Tax liability of 2.31 lakhs (STCG tax rate of 30% on highest tax-slab; 99,300).

The government has not yet specified the grandfathering clause. This means that MLDs released before the budget will be subject to these new rates. Only those MLDs that have been encashed, sold or matured before March 31 will not be affected by the changes. The new rates will be effective from 1 April 2023.

“Issuers may call back MLDs for early redemption, if covenants permit, before March 31. This will be especially possible if the bonds already have at least 12 months of maturity to qualify for the LTCG rate of 10% before the new rates are implemented,” said Aanchal Kaur Nagpal, manager (non- -Banking Rules & Corporate Laws) says Vinod Kothari Adv.

how do mlds work

Most MLDs issued in India are principal-protected MLDs – the principal is protected like any other debt instrument and the coupon payment (payable at maturity) is linked to the performance of another market index or other instrument.

The latter gives the impression that MLDs are little different from regular debt investments. In reality, however, the possibility of additional coupon payments being suspended is contingent on events that are highly unlikely in the short term.

For example, an MLD may be issued on the condition that there will be no additional coupon payment at the time of maturity if the Nifty index corrects more than 75% or the G-Sec bond price increases by 25%. Generally, the maturity period of MLD is anywhere between 13 months to 36 months. The last observation date for the linked instruments (Nifty or G-Sec) would generally be two-three months before the maturity date.

As these events – a more than 75% correction in the Nifty index or a 25% increase in the price of a G-Sec bond – are highly unlikely, MLDs typically act like any other coupon-bearing debt instrument with fixed rates. Are.

The coupon rate or yield is essentially the return payable to the investor at the time of maturity, which is called the pay-off.

Many non-bank financial companies (NBFCs) issue MLDs to raise debt capital. “For NBFCs that were not able to raise capital from banks, these instruments became a major source of funds. For some NBFCs, raising capital through MLD will now be a challenge, unless they are willing to raise their MLD rates,” explains Sanjay Agarwal, Senior Director, CARE Ratings.

MLD also offered flexibility to NBFCs. The rules laid down by the Securities and Exchange Board of India (SEBI) say that companies issuing non-convertible debentures (NCDs) can have only nine securities maturing in a financial year. However, if NBFCs also issue MLDs, they can have an additional five securities maturing in a financial year.

what investors can do

According to data sourced from primedatabase.com MLD market value is high 1 trillion (in terms of outstanding debt).

Crisil Ratings estimates total MLD issuance to almost double 20,800 crore in FY23, from 11,000 crore in FY21. “The number of unique issuers is expected to increase from 50 to 70 in FY11,” says Krishnan Sitharaman, senior director and deputy chief rating officer at CRISIL Ratings.

“HNIs enjoyed these instruments because of the tax-advantages for MLDs within their fixed income portfolios,” says Manish Jeloka, Co-Head Products & Solutions, Sanctum Wealth.

“On a post-tax basis, MLD had earlier offered 8-8.5% returns. Now, to get the same returns, HNIs will have to shift to bonds that are giving 11-11.5% returns on a pre-tax basis. Debt portfolio of HNIs after this change in taxation.

On the other hand, HNIs with a low risk appetite can continue at the MLD despite the change. If MLD issuers are willing to raise their rates, MLDs may continue to be one of the alternative investment vehicles for HNIs, especially as these instruments still offer prime protection on investment.

“Income from listed MLD will be short term capital gain. There will be no need to find a buyer before maturity to deal with the interest income. family of four “5 crore in listed MLDs will pay around 15-20% in the new tax regime,” says Firoz Aziz, deputy CEO, Anand Rathi Wealth.

Investors looking for higher post-tax returns from debt investments can also look at some credit risk strategies. Some debt MF categories may look more tax-efficient. If the holding period is more than 36 months, the investor is eligible for an LTCG tax-rate of 20%, which comes with an indexation benefit.

Wealth managers can introduce new alternative products to offer better post tax yields to HNI clients. “Asset classes such as venture debt and commercial real estate can potentially offer better post-tax yields to HNIs,” says Anshu Kapoor, head and chairman, Nuwama Asset Management.

Commercial real estate products can potentially offer 14-15% pre-tax post-fee (asset management fee) yield.

HNIs can also invest in venture capital debt, which is essentially funding startups by giving loans instead of equity infusion, and can also offer 12% pre-tax yield.

HNIs, who fully understand the risks, can also consider Additional Tier-I (AT-1) bonds of large banks like State Bank of India (SBI), where the yields are slightly higher than regular bonds issued by banks It happens.

Structured and alternative investment products are suitable for sophisticated investors such as HNIs, who have sufficient corpus to adequately diversify their exposure across various asset classes. Post this change, HNIs will need to review their investment portfolio and make appropriate changes if they still want the same returns.