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Getting MLDs at a premium? TDS will dilute your returns


“Don’t I have to pay any tax on the gains?” is what you would have instantly sought to know.

“There’s a capital gains tax at the applicable slab rate, which, in your case, is 20%. But, even after paying the tax, you pocket 2.6% on your investment in just three months!” the RM informs.

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Graphic: Mint

“What is this product?”

“It’s an MLD or market linked debenture. It was among the favourite debt products of high net-worth individuals’ (HNIs) but has lost its sheen since the budget announced capital gains tax at slab rates effective FY 2024-25. But, it doesn’t concern you. In fact, you must use this opportunity to snag this sweet 2.6% offer. That’s a 10.4% annualised post-tax return!”

Sounds like a good bargain? Well, it certainly is. But, here is what your RM won’t tell you. The issuer will deduct tax at source, or TDS, of 10% on the total interest of 2.6 lakh. So, you have to part with 26,000 from the maturity amount of 12.6 lakh that was promised to you. This was of the important announcement made in the budget—listed bonds issued by a company will attract 10% TDS effective FY2023-24. Earlier, only unlisted bonds were subjected to TDS.

So, in place of the 12.6 lakh maturity amount , you will get 12.34 lakh at the time of redeeming the debenture. You will also have to pay capital gains tax of 8,000 (20% of 40,000). Of course, you can claim the TDS back while filing your income tax return.

But, here’s the catch. The full interest of 2.6 lakh and not just the gains that you, as an intermediary buyer, have made will reflect in your Form 26AS. This could mean that the tax officer may refuse the TDS refund, claiming that your tax statements show an interest income and so the TDS is valid. In fact, the officer may ask for additional tax as per your tax slab.

If you are a retail investor and are being suddenly offered MLDs as a good alternative to fixed-income products, you must understand the TDS puzzle before signing up for the deal.

TDS puzzle

The budget changed taxation on MLDs from 10% long-term capital gains tax (after one-year holding) to short-term capital gains (STCG) at slab rates, irrespective of the holding period. This will come into effect from April. HNIs and wealth managers are rushing to sell their MLD holdings before 31 March to unsuspecting retail buyers.

Some would argue that retail investors can snag a good deal by negotiating a high premium from HNIs. But, introduction of TDS on listed bonds will dilute gains.

“TDS outgo for the intermediary buyer in proportion to the capital gains he has made will be huge. He will pay TDS on his as well as the first buyer’s interest income,” says Feroze Azeez, deputy chief executive officer, Anand Rathi Private Wealth Management. In the above example, TDS outgo is close to 80% of the capital gains made. The shorter the holding period for the intermediary buyer, the higher will be the TDS deduction.

While the same can be claimed back at the time of filing ITR, the TDS amount will be locked for a long duration, creating cash flow concerns for small investors.

That’s not all. Investors could also be looking at a marginal increase in credit risk, says Azeez. “A company that was able to raise capital until now using this route would find it a little difficult to raise funds,” he says.

Additionally, the taxpayer may have to face the hassle of tax notices at the time of claiming TDS refund.

“There will most likely be a tax notice as the nature of this transaction can’t be understood electronically. But, it can be easily resolved digitally and won’t lead to litigation,” says Karan Batra, founder, charteredclub.com.

“Such tax notices are not a matter of concern, but a tax notice inadvertently stresses out taxpayers. We advise our clients to not get into such hassles if the gains are not substantial,” he adds.

On being asked what a retail investor should do, Ashish Khetan, founder, Serenity Wealth, says ,“Given the nuances around taxation, it is advisable that investors consult their CAs before taking any decision. Representations have been made by industry bodies to the ministry of finance and hopefully there will be more clarity soon.”

The Finance Industry Development Council (FIDC), a representative body of non-banking finance companies (NBFCs), has in a white paper made recommendations to the finance minister that as the returns on MLDs is now in the nature of STCG, tax should not be withheld on these. “Withholding tax should ideally be applicable only for distribution of interest income—as is the case with regular bonds —to avoid any ambiguity,” the white paper said.

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