Important Keyword: Income from Capital Gains, Income Tax, Market Linked Debentures.
Table of Contents
Market Linked Debentures - Taxation, Benefits, and Risks
Market Linked Debentures (MLD) are a type of non-convertible debentures where the returns are not fixed but rather tied to the performance of the market. Unlike regular coupon-bearing debentures, MLDs don't offer a fixed payoff. Instead, their returns depend on the movement of another security or index, such as the NSE Nifty index or the 10-year government security (G-sec) yield. For instance, if an MLD has a tenure of 30 months, it would pay the investor a predefined Internal Rate of Return (IRR) at the end of the term if the Nifty 50 Index does not fall by more than 75%.
Market-Linked Investments offer investors the potential for either full or partial market downside protection, along with the opportunity for enhanced returns. The tax treatment of market-linked debentures is similar to the taxation applied to bonds and debentures.
Why Market Linked Debentures (MLD)?
Market-linked debentures offer investors a unique opportunity to participate in the upside potential of various markets, such as equity (NSE Nifty) or G-sec, without bearing the full risk associated with direct investment in these assets. Unlike traditional debentures, market-linked debentures do not pay any coupon before maturity. Instead, upon maturity, investors receive a return, providing them exposure to potential market gains.
Investing directly in assets like the Nifty or gold carries the risk of losing a portion of the principal if the value of these assets declines over the investment period. Market-linked debentures mitigate this risk by offering a structured pay-off, allowing investors to benefit from market movements without exposing themselves to undue risk.
Taxation of Listed Market Linked Debentures
Finance Act 2023 – Section 50AA (Effective 1 April 2023)
- All gains on MLDs (listed or unlisted), regardless of holding period, are now classified as short‑term capital gains (STCG) and taxed at the investor's applicable slab rate.
- The previous concession of 10 % long‑term capital gains (LTCG) with a minimum 12‑month holding is abolished.
- The full consideration received upon redemption or sale, minus acquisition cost and transfer expenses, is deemed STCG—no indexation benefit.
- Section 193 exemption for withholding tax on interest is removed, so TDS at 10 % applies to interest on listed MLDs from 1 April 2023 onward.
- Notably, no grandfathering—even MLDs acquired before 1 April 2023 are subject to the new treatment
Finance Act 2024 – Extended Application (Effective 23 July 2024)
- Section 50AA is extended to unlisted bonds and debentures (in addition to MLDs and specified mutual funds) redeemed, sold, or matured on or after 23 July 2024.
- This ensures uniform STCG treatment for all such instruments irrespective of holding period.
Benefits of MLDs
- Potential for Higher Returns: Enable participation in market-linked returns (e.g., equity upside) while retaining some debt characteristics.
- Principal Protection Options: Some MLDs offer capital protection at maturity.
- Alternative Exposure: Act as a hybrid product for investors seeking diversified returns in fixed-income portfolios.
- Custom Structuring: Issuers often tailor payout structures to investor needs.
Note: With STCG at slab rates and no indexation, MLDs can now be less attractive from a post-tax standpoint—even for conservative tertile returns.
Major Risks associated with Market Linked Debentures
- Credit Risk: Investors face default risk if the issuer is weak; ratings are only indicative .
- Market Risk: Underperformance of the linked asset may result in low or zero returns.
- Liquidity Risk: Secondary market is thin; early exit may be difficult.
- Taxation Risk: Recent changes increased tax burden significantly. No grandfathering clause means existing holdings are affected.
- Complexity: Structures involving derivatives and payoff formulas may not be transparent to all investors.
Strategic Investor Considerations
- Understand your marginal tax rate—STCG is taxed at slab, up to 30 % plus cess and surcharge.
- Evaluate whether the potential net returns, after slabs and TDS, justify the exposure.
- Explore principal-protection variants if capital preservation is a priority.
- Always review credit ratings, issuer stability, and underlying index correlation.
- Factor in exit options—many MLDs have limited liquidity.
- Consult a tax advisor—consider tax-efficient alternatives like fixed deposits, plain vanilla NCDs, or debt mutual funds.
Summary Table
| Feature | Pre-April 2023 | Post-April 2023 | Post-July 2024 Update |
|---|---|---|---|
| Tax Treatment | LTCG at 10% (after 12 m) | STCG at slab rate (all) | STCG at slab rate (all) |
| Indexation Benefit | ❌ | ❌ | ❌ |
| Holding Period | 12 months for LTCG | Irrelevant | Irrelevant |
| Interest TDS | ❌ (exempt under Sec 193) | ✅ 10% TDS applicable | ✅ 10% TDS applicable |
| Instruments Affected | Listed MLDs only | All MLDs | All MLDs + unlisted bonds |
Latest Tax Rate Context (as of Budget 2025)
The overall tax regime has been simplified under the new income tax framework, including revised slabs with zero tax up to ₹12 lakh, and adjustments to standard deductions and TDS thresholds. However, MLD gains remain taxed at individual slab rates, independent of these thresholds.
Frequently Asked Questions
1. Are Market Linked Debentures (MLDs) still eligible for long-term capital gains tax benefits?
Answer: No, as per Section 50AA (effective April 1, 2023), all gains from MLDs—irrespective of holding period—are taxed as short-term capital gains at slab rates.
2. What is the tax impact if I sell or redeem MLDs bought before April 2023?
Answer: Even MLDs acquired before April 1, 2023, are taxed under the new rules—gains are treated as short-term capital gains at slab rate. No grandfathering applies.
3. Will TDS be deducted on interest earned from listed MLDs?
Answer: Yes, from April 1, 2023, a 10% TDS is applicable on interest income from listed MLDs under amended Section 193.
4. How are unlisted bonds and debentures taxed after July 23, 2024?
Answer: From July 23, 2024, all unlisted bonds and debentures are taxed as short-term capital gains at slab rate, regardless of holding period.
5. What are the key risks of investing in MLDs under Indian law?
Answer: Key risks include credit risk (issuer default), market risk (low returns if linked index underperforms), liquidity risk (poor secondary market), and high taxation.
6. Can I claim indexation benefit on MLD gains to reduce my tax liability?
Answer: No, indexation benefit is not available for MLDs under the current tax regime.
7. Is there any principal protection in Market Linked Debentures?
Answer: Some MLDs offer principal protection at maturity, but this varies by product and should be verified before investing.
8. Are MLDs suitable for conservative investors post-2023 tax changes?
Answer: Given high taxation at slab rate, lack of indexation, and potential market risk, MLDs may be less attractive for conservative investors. Alternatives like FDs or debt mutual funds may be better suited.
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Official Income Tax Return filing website: https://incometaxindia.gov.in/
