Market Linked Debenture

An MLD looks like a bond and is taxed like nothing else.

It is a debt instrument, but the return is not fixed. It is linked to the performance of an underlying market index or security, so the movement of that underlying determines what the investor gets back. There is normally no periodic coupon — the whole return arrives at maturity as principal plus whatever interest the formula produced.

Two varieties exist. Principal Protected MLDs guarantee the return of the principal at maturity whatever the underlying did. Principal Non-Protected MLDs do not.

Who issues and who buys. MLDs can be issued by companies with a minimum net worth of Rs 100 crore, and are typically bought by high-net-worth and ultra-high-net-worth individuals. Tenure is generally 12 to 36 months.

The tax change is the whole story. Up to FY 2022-23, income from MLDs was taxed much like income from any debenture or coupon bond, and a listed MLD held long enough could be taxed as a long-term capital gain. With effect from FY 2023-24, Section 50AA was inserted, and it does three things:

1. Gains on the transfer, redemption or maturity of an MLD are short-term capital gains irrespective of the period of holding, taxed at the assessee's normal rates.
2. Cost of improvement is taken as nil, whether incurred by the assessee or by a previous owner.
3. It applies to any MLD transferred, redeemed or matured on or after 1 April 2023 — even if the MLD was issued or acquired before that date.

The computation itself is plain: full value of consideration, less cost of acquisition, less expenditure incurred wholly and exclusively in connection with the transfer, redemption or maturity.

Full value of consideration                              xxx
Less: Cost of acquisition of the MLD                    (xxx)
Less: Expenditure wholly and exclusively in connection
      with transfer, redemption or maturity             (xxx)
                                                      -------
Short-term capital gain  (whatever the holding period)   xxx
      taxed at the assessee's normal slab rates

Mrs Anand, in the 30% slab, invests Rs 25,00,000 in a 36-month principal-protected MLD linked to the Nifty. It matures at Rs 34,00,000. Brokerage and charges on redemption come to Rs 15,000.

Full value of consideration      Rs 34,00,000
Less: cost of acquisition        Rs 25,00,000
Less: redemption expenditure     Rs      15,000
                                 -------------
Short-term capital gain          Rs  8,85,000
Tax at 30%                       Rs  2,65,500  (plus cess)

Three years of holding bought her nothing. Under Section 50AA the gain is short-term however long it was held.

Compare a plain listed bond bought and sold for the same amounts and held the same 36 months. Held for more than 12 months it is a long-term capital asset, taxed at 12.5%:

Long-term capital gain           Rs  8,85,000
Tax at 12.5%                     Rs  1,10,625

A difference of Rs 1,54,875 on an identical Rs 8.85 lakh of gain, turning entirely on the label of the instrument. An adviser who compares MLDs with bonds on headline return and not on post-tax return is giving the client the wrong answer.

Chapter 10 (Taxation of Debt Products), section 10.5 Taxation of Market Linked Debentures and section 10.6 Benefits not allowed from capital gain arising from MLDs or the two types of Specified Mutual Funds under Section 50AA. This is a short, heavily-tested section because it is a recent change. Expect a true/false on whether period of holding matters (it does not), a computation of the short-term gain, and a comparison question against a listed bond or an equity-oriented fund.

• Period of holding is irrelevant. Three years, three months — still short-term under Section 50AA.
• The rule follows the date of transfer, not the date of purchase. An MLD bought in 2021 and redeemed in 2024 is caught.
• No indexation, and no cost of improvement. Cost of improvement is deemed nil.
• "Principal protected" protects the principal, not the return. It is not a guaranteed-return product, and the protection is only as good as the issuer.
• The same Section 50AA treatment applies to Specified Mutual Funds. A question naming an SMF is testing the identical rule.
• Normal slab rates, not a flat 20%. For an investor in a lower slab the outcome is far less punitive than the headline suggests.