Budget 2023: Impact on Fixed Income Investments

The FY24 budget brought significant changes to the landscape of fixed income investments. This article delves into these changes and their implications for investors. With a focus on the keyword “fixed income investment,” we will analyze the new tax regulations on listed bonds, market linked debentures, InvITs/REITs, and discuss how these changes affect investors, particularly in terms of post-tax yields and investment strategies.

Listed Bonds

New Tax Regulations

Listed bonds will now be subject to a withholding tax of 10%, aligning them with fixed deposit investments with banks and other financial institutions. Previously, these bonds were exempt from any withholding tax. The government introduced this change to ensure better compliance with tax obligations on income earned from these instruments.

Impact: Neutral to Marginally Negative

The immediate post-tax yield on listed bonds remains unchanged, which may not significantly deter investors. However, the lower surcharge for Ultra-HNI investors could result in higher effective post-tax returns for this group. Smaller investors, who often prefer receiving payments without tax deductions at the source, might find this change slightly disappointing due to reduced immediate cash inflows.

Market Linked Debentures (MLDs)

New Tax Regulations

Capital gains on market linked debentures will now be classified as short-term capital gains and taxed at the marginal tax rate applicable to any investor, regardless of the holding period or the listing status of the instrument. Previously, listed MLDs held for more than 12 months were subject to long-term capital gains tax at a rate of 10%.

Impact: Negative for MLD Market

This change negatively impacts the attractiveness of MLDs, which were favored by high-net-worth individuals (HNIs) and family office investors for their lower tax liabilities compared to other fixed income products. The market for listed MLDs, estimated at around Rs. 25,000 crores, is likely to see a shift as investors move towards other fixed income products like fixed coupon or zero-coupon bonds, pass-through certificates (PTCs), exchange-traded funds (ETFs), Alternative Investment Fund (AIF) units, and debt mutual funds. Additionally, there may be a rush to liquidate existing MLDs before the new tax regime takes effect.

InvITs/REITs

New Tax Regulations

The budget proposes higher taxes on investments in units issued by Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs). These entities typically make four kinds of payments to unit investors: interest, dividend, rental income, and repayment of debt. While the first three were always taxable, repayment of debt was previously tax-exempt. This exemption has now been removed.

Impact: Negative for REIT/InvIT Market

The removal of the tax exemption on ‘repayment of debt’ will significantly reduce the post-tax yield for investors, making REITs and InvITs less attractive. This component often contributed a substantial portion of payouts to unit investors, and its taxation will likely lead to a decline in investor interest in these instruments.

Lower Surcharge

New Tax Regulations

The surcharge on income tax for the highest income bracket (annual income above Rs. 5 crore) has been reduced from 37% to 25%. Consequently, the effective tax rate for these ultra-HNI investors decreases from 42.74% to 39%.

Impact: Positive for Fixed Income Investments

This reduction in the surcharge makes fixed income products more attractive to ultra-HNI investors due to the lower tax outgo. With more disposable income, these investors are likely to increase their allocation to fixed income investments.

Miscellaneous Changes

Real Estate and Insurance

The budget caps the deduction from capital gains on residential property reinvestment under Sections 54 and 54F at Rs. 10 crores. This change is expected to reduce investments from ultra-HNI investors in the high-end residential property market, potentially channeling more funds into the fixed income market. Additionally, the tax exemption status has been withdrawn for payments under insurance policies (excluding ULIPs) where the cumulative premium exceeds Rs. 5 lakhs. This change applies only to policies issued from April 1, 2023, onwards. The taxation of high-value insurance products, coupled with no new incentives on premiums paid, may diminish the attractiveness of insurance products compared to fixed income investments.

Learn more about bond taxation here 

Impact of Previous Year Policies on Fixed Income Investments

To understand the full scope of how the FY24 budget affects fixed income investments, it is essential to consider the impact of previous year’s policies. These earlier changes set the stage for the current adjustments and provide a comprehensive view of the evolving regulatory environment.

Reduction in Corporate Tax Rates

In the previous fiscal year, the government reduced corporate tax rates, which had a positive impact on the fixed income market. Lower corporate taxes improved the credit quality of corporate issuers, making corporate bonds more attractive to investors seeking stable and reliable fixed income investments.

Introduction of New Investment Instruments

The government has been proactive in introducing new investment instruments to diversify the fixed income market. For instance, the introduction of Bharat Bonds, which are exchange-traded funds (ETFs), provided retail investors with a low-cost option to invest in high-quality public sector bonds. This initiative aimed to deepen the bond market and provide more choices for fixed income investors.

Enhanced Disclosure Norms

Enhanced disclosure norms introduced in the previous fiscal year aimed to improve transparency in the fixed income market. Issuers of bonds and other fixed income instruments are now required to provide more detailed information on their financial health and the risks associated with their offerings. These measures have bolstered investor confidence and contributed to a more robust fixed income market.

Digital Initiatives for Bond Trading

The previous year also saw the implementation of digital platforms for bond trading, making it easier for retail investors to access fixed income investments. The introduction of online bond trading platforms and mobile applications has democratized access to these instruments, encouraging more participation from individual investors.

Impact on Fixed Income Investments

These previous year’s policies laid the groundwork for a more inclusive and transparent fixed income market. The reduction in corporate tax rates improved issuer credit quality, while the introduction of new investment instruments and enhanced disclosure norms boosted investor confidence. Digital initiatives further expanded market access, making fixed income investments more appealing to a broader range of investors.

Conclusion

The FY24 budget introduces several changes that impact fixed income investments. While listed bonds see a neutral to marginally negative effect, the attractiveness of market linked debentures and REITs/InvITs declines due to new tax regulations. However, the reduction in surcharge for ultra-HNI investors makes fixed income products more appealing to this group. Investors will need to adjust their strategies to navigate these changes and optimize their portfolios for the best possible returns in the new fiscal environment.

By staying informed and adapting to these regulatory changes, investors can continue to leverage fixed income investments to achieve their financial goals. For more insights and investment opportunities, visit the Aspero platform today.