Capital Gains in case of a unit of Specified Mutual Fund or Market Linked Debentures
Introduction: In today’s scenario, a lot of people are investing in the security market. With India’s MLD landscape changing since past years, there has been a major change in MLDs, particularly with respect to MLD taxation. MLDs have emerged as a good option for high-net-worth individuals (HNIs) looking for a fixed-income investment vehicle over the years along with a pinch of market gains. High Net Worth Individuals frequently gravitated towards MLDs in the past because these instruments enjoyed preferred tax status for many years.
In the Finance Act, 2023 special provisions were introduced for computation of capital gains in case of units of specified mutual fund or market linked debentures. This has led to a major change in the tax impact of such securities.
In the transactions conducted in listed securities, it has been noticed that a variety of hybrid securities that combine features of plain vanilla debt securities and exchange traded derivatives are being issued through private placements and listed on stock exchanges. It is seen that such securities differ from plain vanilla debt securities.
As per the budget memorandum, the main intent behind this amendment is that these securities are derivatives which should normally be taxed at applicable rates. In case of MLDs, they give variable interests as they are linked with the performance of the market. Prior to amendment, such MLDs were being taxed as long term capital gain at the rate of 10% without indexation. However, the amendment has led to taxability at applicable rates on such MLDs like any business income.
In order to tax such gains on short term basis, a new section 50AA has been inserted. Section 50AA prescribes the special provisions for computation of capital gains in case of a unit of specified mutual fund or market linked debentures.
Section 50 AA:
Section 50AA is a newly inserted section with effect from AY 2024-25, that covers the provisions for taxability of specified mutual funds and market linked debentures.
To understand the section, let us first understand the definition of the terms – Specified Mutual Fund and Market linked debentures
Specified Mutual Fund- It means a mutual fund that satisfies the following two conditions –
1. The fund has invested not more than 35% of its total proceeds in equity shares of domestic companies &
2. The assessee has acquired the units on or after 01.04.2023
Market linked debentures – Market linked debentures are non convertible debentures. The returns on such debentures are not fixed. They are linked to the performance of certain market index. Like – NSE, etc.
The returns are determined on the basis of the performance of the underlying index.
The definition as per section 50AA – A security which has an underlying principal component in the form of debt security and where the returns are linked to the performance of such indices.
Example – A Ltd. Issues market linked debentures on 01.04.2024 for 15 months at the rate of interest on 8%, subject to the condition that the value of Nifty 50 does not fall below 85% of the value as on the date of issue. The value of Nifty 50 as on 01.04.2024 is 12000. If the value falls below 10200 (below 85%), the company will pay only the principal.
If the value goes above 85%, then the debenture holders will receive interest as well along with principal.
In India, SEBI permits only principal protected MLDs.
With this new section, the taxability of MLDs and specified mutual funds has undergone a major change.
TRANSFER OF MARKET LINKED DEBENTURES/SPECIFIED MUTUAL FUNDS
Section 50AA prescribes the taxability of NLDs or specified mutual funds. As per the deeming provisions of section 50AA, such debentures or mutual fund units shall be treated as short term assets and the gain/loss shall be treated as short term gain or loss irrespective of the period of holding of such assets.
So, in such case the mode of computation shall be as given –
Full value of consideration ——
Less: Transfer Expenses (STT not allowed) ——
Less: Cost of acquisition ——
Short Term Capital Gain ——
Let us understand this with a numerical case –
|
Name of fund/ MLD |
SBI MF – (X) | SBI MF – (A) | SBI MF – (Y) | Debenture in ABC ltd.(MLD) |
| Date of acquisition | 01/03/2023 | 01/06/2023 | 01/07/2023 | 01/05/2021 |
| Amount invested | 12,00,000 | 12,00,000 | 12,00,000 | 12,00,000 |
| Amount invested in equity shares in domestic companies | 30% | 20% | 70% | NA |
| Date of sale | 1/04/2027 | 1/07/2027 | 1/08/2027 | 1/06/2027 |
| Amount of sale | 18,00,000 | 18,00,000 | 18,00,000 | 18,00,000 |
| Is it a specified mutual fund for the purposes of section 50AA | No (As the MF is acquired before 01.04.2023) | Yes (As the MF is acquired on or after 01.04.2023 & amount in equity is not more than 35%) | No (As the amount invested in equity is more than 35%) | Yes(As it is a MLD) |
| Section applicable for taxation | 112 | 50AA | 112A | 50AA |
| Capital Gain | 3,60,000 | 6,00,000 | 6,00,000 | 6,00,000 |
| Assumed Indexed cost of acquisition | 15,60,000 | NA | NA | NA |
In the above example I have considered four situations, having same purchase and sale value so as to compare the different situations prior and after amendment.
Case -1 SBI MF – X (Position before amendment)- In this case the investment in equity is not more than 35%, however as the acquisition date is prior to 01.04.2023, it does not fall in the category of specified mutual fund u/s 50AA. In this case being long term asset, the section applicable for taxability will be 112. The gain as computed above is 3,60,000(as it is assumed that the assessee will take the benefit of indexation.)
Case – 2 SBI MF – Y (Position after amendment)- In this case the investment in equity is not more than 35% and the acquisition date is on or after 01.04.2023, thus, it falls in the category of specified mutual fund u/s 50AA. As per section 50AA, irrespective of period of holding, the specified mutual fund falls in the category of short term capital asset and the gain on such assets shall be short term capital gain. Therefore, in this case the benefit of indexation will not be given and the gain as computed above is 6,00,000. The tax shall be calculated as per regular applicable rate on the assessee.
Case – 3 SBI MF – A – In this case the investment in equity is more than 35%, it is outside the purview of section 50AA. As per the conditions, section 112A shall apply. As the period of holding is more than 1 year, it is a long term capital asset taxable as per the provisions of 112A. So, amount of gain above 1,00,000 shall be taxable @10%.
Case – 4 MLD(ABC Ltd.) – In this case the transfer is of MLD, so section 50AA shall be applicable. As mentioned above, indexation benefit shall not be available and the gains shall be short term irrespective of the period of holding. The tax shall be liable as per the regular rates applicable to the assessee. Even though the MLDs were acquired in 2021, section 50AA shall be applicable.
Conclusion:
Upon analyzing the scenarios, it becomes evident that investments in specified market-linked debentures will incur higher tax liability from Assessment Year 2024-25. Investors considering such funds or MLDs on or after April 1, 2023, should factor in the altered tax implications.
Additionally, the amendment lacks any grandfathering provisions. This means that investors who purchased MLDs before the amendment and sell them afterward will be subject to the new provisions.
This is the applicability and impact of Section 50AA, which comes into effect from Assessment Year 2024-25. It represents a significant change in the tax treatment of specified mutual funds and MLDs, requiring investors to carefully assess their investment strategies and tax implications.
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