Budget 2024-25 throws STCG googly at sovereign wealth, pension funds

It proposes to tax gains arising on transfer or redemption or maturity of unlisted debentures or bonds to be deemed as short-term capital gains

The Union Budget has sprung a surprise for sovereign wealth funds (SWF) and pension funds (PFs). The two classes of investors were exempted from long-term capital gains (LTCG) on specified debt investments. This was done to promote investment by SWFs in domestic businesses, mainly those developing or maintaining infrastructure facilities. To be eligible to gain such exemption, a SWF was required to make an investment before March 31, 2024 and the holding period was set at least three years. Interestingly, the interim Budget in February had extended the investment period by one year to March 2025.

On Tuesday, the government proposed to tax gains arising on transfer or redemption or maturity of unlisted debentures or bonds to be deemed as short-term capital gains (STGC) irrespective of the holding period. As a result, the gains on unlisted debentures will be as per the applicable rates for both residents and non-residents, which in many cases will be the maximum marginal rate of 35 per cent.

“By deeming unlisted bonds and debentures to be short-term capital assets, the Budget has effectively removed this exemption for SWFs and PFs investing in specified unlisted bonds and debentures,” said Suresh Swamy, partner, Price Waterhouse & Co.

“The Budget announced in February 2024 had extended this timeline to March 31, 2025 and also released suitable circulars recently. Thus, it seems to be an oversight to have removed the benefits for SWFs/ PFs on investment in unlisted bonds and debentures,” he said.

Rajesh Gandhi, partner at Deloitte India, echoed the same sentiment, “The exemption for SWFs and PFs is available only for long term capital gains. So that seems to be an unintended consequence of the amendment. It is unintended because even interest income earned by SWFs and PFs is exempt from tax.”

Among unlisted debentures, compulsory convertible bonds (CCDs) are popular instruments used by foreign funds to invest in the unlisted space. These hybrid instruments get compulsorily converted into equity shares after a certain period. They have gained popularity as it allows the investors to earn regular interest income from the investee company. Also, they get to avail the benefit from the potential growth in the company due to the ‘equity’ component.

Experts said since CCDs are classified as unlisted debentures, they will now attract higher taxes unlike earlier where non-residents had to pay 10 per cent LTCG on a holding period of 36 months.

For foreign funds, their tax outgo will now depend on their respective treaties.

“Under certain treaties between India and Mauritius, Singapore, Ireland, France, Japan, Korea and Netherlands gains on sale of non-equity assets is exempt from tax in India. So that benefit will continue since the budget does not change the classification of income on redemption or transfer,” said Gandhi.