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What are Market-Linked Debentures and why do market-linked debentures enjoy lower tax-rates?

IME Capital Investment Queries provide answers to common investor queries that are directly written by IME Capital’s Central Investment Team. This helps ensure centralised, common and transparent communication of our thoughts to all investors (& potential investors) of IME Capital, and helps mitigate against the disparate communication common in the wealth management industry.

Written by IME Capital’s Investor Desk on July 5, 2022

Market-linked debentures are bonds, where the amount of interest payments are not fixed but linked to some market index (such as the Nifty, G-sec index, currency rate etc). These typically are structured in a manner, where the payout is defined as long as the market index is within a particular band, and the payout increases or decreases at market levels that are outside that band.

In order to benefit from the lower-taxation of MLD’s, many issuers have started issuing MLD’s where the market band for the defined payout is so large that is becomes very unlikely for any other situation to play out (helping provide investors clarity on their payout, while benefiting from a lower tax-structure of MLD’s).

Since the payout of these instruments are linked to a market-index, they are considered equity and benefit from the substantially lower equity-taxation rate. The tax-rate would depend on whether the MLD’s are listed or unlisted

  • Listed MLDs: Taxed at 10% for a holding > 1 year
  • Unlisted MLDs: Taxed at 20% (with indexation benefits) for a holding > 24 months

It is important to note, that in order to enjoy the beneficial taxation of MLD’s these bonds have to be sold prior to maturity (typically the issuer operates as a market-maker and buys back these bonds from investors). If these bonds are allowed to mature, the income earned from these bonds will be subject to the maximum marginal tax rate for the investor.