Section 50AA outlines special rules for calculating capital gains on Market-Linked Debentures and certain Specified Mutual Funds. Under this provision, such gains are treated as Short-Term Capital Gains, irrespective of how long the investment was held.
In this article, we will understand what section 50AA of the Income Tax Act is, its impact on investors, and the compliance and reporting requirements.
What is section 50AA of the Income Tax Act?
Section 50AA has been newly inserted into the Income Tax Act. This section deals with taxation on market-linked debentures. Before we understand the intricacies of the section, let us understand what market-linked debentures are.
Market-linked debentures (or MLDs for short) are financial instruments that consist of a debt component alongside returns linked to the performance of underlying securities or indices in the market. The Securities and Exchange Board of India (SEBI), India's regulatory authority, categorises or regulates these securities as market-linked debentures.
According to the new section 50AA of the Income Tax Act, any capital gain arising due to the transfer, maturity, or redemption of this security will be considered a short-term capital gain, where the holding period of the security will have no influence.
Overview of Market-Linked Debentures (MLDs)
- Return profile: Unlike conventional bonds that provide fixed interest payouts at regular intervals, MLDs deliver returns tied to the performance of an underlying index or asset. This structure allows for the possibility of higher gains during favourable market conditions but may also result in little to no returns if markets decline.
- Risk exposure: Compared to fixed-income instruments, MLDs carry greater risk since their performance is market-driven. This makes them behave more like equity-linked products than stable debt investments.
- Payout structure: While traditional debentures generally disburse interest semi-annually or annually, MLDs typically offer returns only at maturity. The payout depends on whether predefined market or asset-linked benchmarks are met.
- Tax treatment: The taxation of MLDs differs from standard fixed-income products, where interest income is taxed as per the investor’s income slab. Depending on the structure, MLD returns may be classified as capital gains, which can sometimes provide more favourable tax treatment.
What is section 50AA's specified mutual fund
In the context of section 50AA, a specified mutual fund is a financial instrument in which not more than 35% of the total investment amount of the fund is invested in equity shares of different domestic businesses. The types of mutual funds in this category include ELSS (Equity Linked Savings Scheme), infrastructure debt funds, pension funds, Rajiv Gandhi Equity Savings Scheme (RGESS), and other sector-specific funds.
Detailed explanation of Section 50AA
Section 50AA of the Income Tax Act covers the charging of capital gains involved with any transactions arising from trading of market-linked debentures and specified mutual funds. The resultant capital gains from the buying, selling, redemption or maturity of such debentures will be treated as STCG or short-term capital gain.
Earlier, all market-linked debentures were taxed at a fixed 10% rate. However, since the introduction of this new section by the Finance Act 2023, all income arising from market-linked debentures will be taxed as per the income tax slab rate of the investor.
Expenses such as Securities Transaction Tax (STT) paid by an investor will not be allowed as a deduction when calculating this capital gain.
Impact on investors
The introduction of section 50AA has brought some major changes in the taxation of the market-linked debentures. Let us understand how this affects you as an investor.
Also read: Income tax return extended date for AY 2024-25
Classified as a short-term capital gain
An asset or financial instrument is said to have attracted a long-term capital gain when it is held for more than 36 months for financial instruments and 12 months for financial assets. Now, due to section 50AA, all transactions involving market-linked debentures will come under short-term capital gains irrespective of the period for which they were held by the investor. Investors might now change their strategy due to the new rules.
Charged as per individual income tax slab rate
Earlier, long-term capital gains were charged at 20%. However, short-term capital gains are charged as per an individual’s income tax slab rate. This would result in a greater tax liability for investors who fall under the higher tax bracket.
Securities Transaction Tax (STT) and section 50AA
Securities Transaction Tax, or STT, was a small expense that investors had to bear when trading securities on the stock exchanges. However, due to section 50AA, the STT paid on debentures will no longer be allowed as a deduction when capital gains are calculated.
As STT is not allowed as a deduction, the effective tax that an investor has to pay will increase, ultimately leading to reduced net returns for the investor if they invest in market-linked debentures.
Also read: Direct Tax Code 2025
Tax Computation under Section 50AA
Mr. A earns Rs. 10,00,000 from business and Rs. 2,00,000 as capital gains from selling a market-linked debenture. Compute his tax liability for FY 2024–25 under the new regime.
Computation of Taxable Income
Particulars |
Amount (Rs.) |
Business Income |
10,00,000 |
STCG from market-linked debenture |
2,00,000 |
Total Taxable Income |
12,00,000 |
Computation of Tax Liability
Tax Slab |
Rate |
Amount (Rs.) |
Up to 3,00,000 |
0% |
0 |
3,00,001 – 7,00,000 |
5% |
20,000 (4,00,000 × 5%) |
7,00,001 – 10,00,000 |
10% |
30,000 (3,00,000 × 10%) |
10,00,001 – 12,00,000 |
15% |
30,000 (2,00,000 × 15%) |
Total Tax Liability (before cess) |
|
80,000 |
Compliance and reporting requirements
According to section 50AA of the Income Tax Act, certain compliance and reporting requirements must be adhered to when dealing with capital gains from MLDs and specific mutual funds.
Here are the compliance and reporting requirements according to the new rule:
Maintain all records properly
Investors are required to maintain a comprehensive record of market-linked debentures and all the transactions they carry out. It should include the relevant dates, the cost, the date of sale, and the cost at which it was sold. You also have to provide evidence that the relevant STT was paid and was not claimed again as a deduction in the computation of your capital gains.
Computing the capital gains tax
Investors are required to compute capital gains by subtracting the acquisition cost from the sale or redemption value. It is important to note that the acquisition cost should exclude any indexation or Securities Transaction Tax (STT) paid.
Reporting requirements
To file income tax returns under Section 50AA, you have to declare capital gains eligible under the section, which must be reported in the annual income tax filings.
It is the responsibility of the taxpayers to utilise the designated schedules within the tax return forms to declare short-term capital gains, typically found in Schedule CG of the ITR forms.
Also read: Section 112A of Income Tax Act
Expert opinions and industry reactions
Experts think that this new section might discourage investors from investing in MLDs and specific mutual funds because of the high tax liabilities. To minimise the tax burden, investors might now consider investing in a blend of hybrid funds that do not meet the 35% investment in domestic companies criteria. In such a scenario, they will be taxed at a flat 20% and can also avail of the benefits of indexation.
Amendment in Section 50AA of the Income Tax Act
Section 50AA was introduced through the Finance Act, 2023, with the objective of tightening tax compliance and bringing more uniformity in the taxation of capital gains. Earlier, instruments such as Market-Linked Debentures (MLDs) were structured in a way that allowed investors to benefit from lower tax rates. The amendment closed this loophole by standardising the treatment of such gains.
This provision is also aligned with the government’s larger effort to improve transparency and establish parity in taxation across different categories of financial products. It reflects a clear intent to create a fairer and more balanced tax system.
Why does it matter to you?
For investors who currently hold, or are considering investing in MLDs, understanding Section 50AA is essential. The way gains are taxed has changed considerably, which may directly affect the post-tax returns from these instruments. The impact is particularly notable for those falling in higher income tax brackets, where the tax outgo can be significant. Awareness of these provisions helps investors make better-informed choices and, if necessary, consider alternative investment avenues that may be more tax-efficient.
Key highlights of Section 50AA
- Applicability:
The section applies to Market-Linked Debentures (MLDs) acquired on or after 1st April 2023. - Capital gain computation:
Capital gains from the transfer, redemption, or maturity of such debentures will be determined by deducting the cost of acquisition from the redem
ption value or sale consideration. - Taxation:All such capital gains are classified as short-term capital gains (STCG), even when the debentures are held for more than 36 months. The gains are taxed at the slab rate applicable to the investor, which makes MLDs comparatively less efficient from a tax perspective.
- No indexation benefit:
As these gains are treated as short-term, the benefit of indexation cannot be claimed. - Impact on high net-worth individuals (HNIs) and institutions:
This provision has a significant effect on HNIs and institutional investors who earlier used MLDs as a means of tax arbitrage. With Section 50AA in place, such strategies have lost their advantage.
Conclusion
Section 50AA of the Income Tax Act now classifies all gains resulting from the transfer, redemption, or maturity of market-linked debentures or specified mutual funds as short-term capital gains. Investors will attract the tax liability based on their personal income tax slab rate instead of a flat deduction. They will also have to forgo any indexation benefits in the form of STTs, which will further add to their tax liability.
