Budget and HNIs: How some investments are unattractive and what the wealthy must do

The Union Budget 2023 has been a bit hard on many financial products that high net worth individuals (HNIs) are known to invest in. Investments in market-linked debentures (MLDs), real estate investment trusts (REITs) and life insurance policies will now face full taxation, taking away much of their attraction for wealthy investors.

As a HNI looking to wade through the budget and looking to make an informed call on your investments, here’s how the new tax proposals will affect your investments. We also state some alternatives that could help such investors choose better options.

Insurance policies, MLDs and REITs face tax axe

As a HNI, you may have liked to have tax-free proceeds from life insurance products. Even though the returns are low – generally 4-5% – many wealthy individuals buy endowment and moneyback life insurance policies. They also buy large single-premium policies. Now, the budget has played spoiler with such options. Given that all proceeds from life insurance products with premiums in excess of Rs 5 lakh would be taxed at your slab, as a HNIs, you may have to rethink your investments. With already low returns, the taxation angle would make the returns all the more unattractive. And remember, the premium limit of Rs 5 lakh is not on individual policies. It is the total applicable to all your endowment, moneyback and unit-linked policies. Only term insurance premium is left out.

The Budget has also taken the shine off another HNI favourite – market-linked debentures or MLDs.

MLDs are fixed income products. But the returns on the debentures are linked to an index – say the Nifty. A specific return is promised to MLD holders only if the underlying index moves by a certain extent. Now, according to the budget documents, hybrid securities that combine features of plain vanilla debt securities and exchange traded derivatives were being issued through private placements and listed on stock exchanges.

With ticket sizes ranging anywhere from Rs 25 lakh to Rs 1 crore, MLDs currently offer equity-like taxation (10%) on gains made beyond a one-year holding period.

But given the involvement of derivatives in these MLDs, the budget proposal seeks to tax the entire proceeds of the MLDs. And there are no demarcations in short or long-term either and so all gains will be taxed at your slab rate irrespective of the holding period.

Then the serious blow on a solid dividend paying investment. All payouts from real estate investment trusts (REITs) would be taxed irrespective of the head under with such amounts are distributed.

REITs distribute cashflows in the form of interest, dividend, rental income, and repayment of debt. The payouts under the first three heads are taxed at your slab, while the amount paid under the ‘repayment of debt’ head is tax free.

Currently, payouts under the ‘repayment of debt’ category usually represented 45-90% of most REIT payouts.

The budget memorandum notes that repayment of debt is actually an income of the unit holder which does not suffer taxation either in the hands of business trust or in the hands of unit holder. Therefore, it will now be fully taxed.

The REITs of Mindspace Business Parks, Brookfield India and Embassy Office Parks offer 5.5-7.5% dividend yield currently. Because the entire payout will now suffer tax, HNIs who fall in the highest tax brackets will see the yields on REITs shrink to 4.5% range.

Thus, for HNIs a whole lot of investments that yielded 5.5% to double-digit returns will now earn sub-5% yield, making them quite unattractive.

What are the alternatives?

HNIs can start looking at the more traditional mutual fund and bond options for their investments. You can consider debt funds, especially target maturity funds and Bharat Bond ETFs that come with 4-15 years tenor. Currently, yields are in the 7.2-7.6% range for such funds and ETFs. You can consider some of these for your investments as these carry indexation benefits. You can earmark large amounts of money for specific life goals with target maturity funds.

In India, inflation is generally sticky. The average rate is more likely to be around 6%. Such being the case, you will pay fairly low tax on the final proceeds, given the indexation benefits. Your final returns or yields post tax are more likely (though not assured) be above 6.5%, if you hold these funds till maturity.

If you are one of those wealthy persons who still likes to have tax-free investments in your portfolio, you can consider tax free bonds. For safety and tax-free proceeds, the bonds of NABARD, IREDA, HUDCO, REC and NHAI are good alternatives. These companies are all government navaratnas or mini ratnas with the highest credit ratings and hence are quite safe for your interest and principal repayments.

You can get in excess of 5.5% returns from these bonds. These are post-tax returns and still reasonably attractive compared to other fixed income options such as deposits for HNIs.

Another alternative is to invest in government bonds. You can consider floating rate government securities. For example, the GOI FRB 2033 currently offers 8.15% yield.

Proposed new tax regime suited for HNIs

One welcome announcement in the Union Budget was for those in the highest tax bracket. There is now a reduction in the peak surcharge rates for the wealthy, if they choose to opt for the proposed new tax regime without deduction benefits. By reducing the surcharge from 37% currently to 25% from the new financial year, the effective peak tax would come down to 39% at the peak.

When you consider HNIs with, say, Rs 10 crore annual income, the savings would be to the tune of Rs 38 lakh if they move from filing returns under the old tax regime to the new one.

For those with substantial dividend income and payouts or income streams from other sources, it may be a good idea to shift to the new tax regime from the next fiscal.

As a HNI, 80C tax investments or home loan deductions may carry very limited benefits for you to bring down your overall taxes. And if there is nothing substantial on these fronts, shifting to the new tax regime will reduce your peak rate from 42% levels to 39%.

Thus the Union Budget seems like a nudge to HNIs for changing their investment preferences and shifting to the new tax regime.

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