Budget 2023 I Income-tax rule change may dampen investor interest in market-linked bonds: Dealers

Nirmala Sitharaman delivered her shortest Budget speech on February 1. A round-up of the big Budget stories (Representative image)

Bond market dealers are upset over a change in the income tax rules related to market-linked debentures (MLDs) as it takes away the benefit of tax arbitrage and could repel investors.

“It will be a big blow for MLD issuers and investors. The MLD market was thriving all these days due to tax arbitrage,” said Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincorp.

Also read: New income tax slabs, hike in rebate: 5 big personal income tax changes in Budget 2023

The rule change 

In Budget 2023, the government has announced the insertion of Section 50AA in the Income Tax act, effective April 1, 2024.

The section pertains to special provision for the taxation of MLDs, which are a type of non-convertible debenture wherein the returns are not fixed but linked to the performance of a certain market index. They typically have tenure ranges from 12 to 60 months.

The new section allows taxing the capital gains arising from the transfer or redemption or maturity of these securities as short-term capital gains at applicable rates.

According to the Finance Bill, the rationale for the change in Act is to treat the full value of the consideration received or accruing as a result of the transfer or redemption or maturity of the MLDs.

“With the inclusion of Section 50AA in the Budget announcement, the attraction towards MLD as a tax-arbitrage instrument will diminish,” Srinivasan said.

Also read: Budget 2023 | Centre to borrow record Rs 15.43 lakh crore via bonds in FY24

The current status 

At present, MLDs are taxed as a long-term capital gain at the rate of 10 per cent without indexation and investors enjoy tax arbitrage by selling these bonds ahead of maturity. Whenever MLD bondholders sell these bonds before maturity, they become eligible for the capital gains tax and are not taxed as per their income tax slab.

However, there is a silver lining.

“The insertion of a new section to the I-T Act will reduce demand for MLD but simultaneously increase demand for government securities STRIPS,” said Umesh Kumar Tulsyan, Managing Director, Sovereign Global.

In the Budget, the government has announced market borrowing of Rs 15.43 lakh crore in 2023-24 to finance its fiscal deficit of 5.9 percent of gross domestic product. On a net basis, the Centre's borrowing for the next year has been pegged at Rs 11.8 lakh crore, up from Rs 11.19 lakh crore in 2022-23.