This article analyses the impact of the changes to fixed-income instruments announced in the budget for FY24.

1. Listed Bonds

Listed bonds would now be subject to withholding tax of 10%, in line with fixed deposit investments with banks and other financial institutions. Such bonds were exempt from any withholding tax earlier. This has been done to ensure better compliance on tax payable on income earned from these instruments.

Impact: Neutral/ Marginally Negative

No material impact as post-tax yield on these instruments remains the same. In fact, effective post-tax returns for Ultra-HNI investor category would be higher due to lower surcharge (see the section below). However, investors – especially the smaller investors – prefer payments to happen without any tax deduction at source so that they get higher cash upfront in their hands and would be slightly disappointed. 

2. Market Linked Debentures

Capital gains on market linked debentures (MLDs) will now be classified as short-term capital gains and taxed accordingly – effectively at the marginal tax rate applicable on any investor.  This is irrespective of the holding period of the investment and the listing status of the instrument. 

Earlier, for listed MLDs with a holding period of more than 12 months, long-term capital gain was applicable which was taxed at a rate of 10% only.   

Impact: Negative for MLD Market

Market linked debentures (MLDs) were a popular choice of instrument for HNIs and family office investors due to lower tax outgo compared to fixed income products in case the holding period was more than 12 months. Issuers also benefited through marginally lower cost of funding and some regulatory concessions (like availability of additional ISINs and exemption from electronic book building process through exchange platforms). 

The taxation arbitrage available to MLDs has now been plugged. Listed MLD market was estimated to be around Rs. 25,000 crores. The investors in this market will gravitate towards other fixed income products like fixed coupon or zero-coupon bonds, PTCs, ETFs, AIF units and debt mutual funds. There may also be a rush from investors to liquidate these instruments (especially where the holding period has already exceeded 12 months) before the new tax regime comes into effect.

3. InvITs/ REITs

The budget proposes higher tax outgo on investments in units issued by REITs/ InvITs. Typically, REITs or InvITs make four kinds of payments to the unit investors: 

  • Interest 
  • Dividend 
  • Rental income 
  • Repayment of debt 

While the first three components were always taxable in the hands of the investor, there was no tax applicable on distribution of income under the header ‘Repayment of debt’ – either at trust level or in the hands of the investor. This exemption will now no longer be applicable.  

Impact: Negative for REIT/ InvIT Market

Distribution under ‘Repayment of debt’ contributed to significant portion of payouts to the unit investors. Levy of tax on this component will substantially reduce the post-tax yield for the investors and make such investments less attractive. 

4. Lower Surcharge

Surcharge applicable on income tax in the highest income bracket (above Rs. 5.0 crore annual income) has been reduced to 25% from 37% earlier. This would reduce the effective tax rate (after factoring the surcharge & cess) applicable on such investors to 39% from 42.74% earlier.

Impact: Positive

Investments in fixed income products become more attractive for the ultra-HNI investors with annual income above Rs. 5 crore due to lower tax outgo.

5. Miscellaneous

Deduction from capital gains on residential property re-investment under Section 54 and 54F has been capped at Rs. 10 crores. This would reduce investment from ultra-HNI investors in high end residential property market. Some of these funds may now get channelled to fixed income market.

Similarly, tax exemption status has been withdrawn for payments under insurance policies (other than ULIPs) where the cumulative premium amount is more than Rs. 5.0 lakhs. However, this is applicable only for policies issued from April 01, 2023 onwards, and not for existing policies. Taxation of high-value insurance products together with absence of any incremental incentives on premiums paid in the budget, will somewhat diminish the attractiveness of insurance products compared to other asset classes – including fixed income products.