Section 50AA of the Income Tax Act states that any capital gains that arise from the transference of debentures, their redemption, or maturity would be classified under short-term capital gains no matter how long or short the holding period. As a result, the Securities Transaction Tax (STT) cannot be used as a deduction while computing capital gains.
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.
Also read: Income Tax Slabs for FY 24-25
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.
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.
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.
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.
