Budget 2023: How the budget affects HNIs? Some good, some bad news

The Budget 2023 was a mixed bag for high-net-worth individuals (HNIs). From a reduction in surcharge rate for HNIs to taxing capital gains from market-linked debentures as short-term capital gains, there were some good, and some bad news.

Overall the experts were extremely pleased by the 2023 budget, terming it as growth-oriented. This was the last full budget before the 2024 General elections. The Modi government also announced relief measures to woo the middle class with incentives such as tax rebates. Other key highlights of the Budget included the increase in capital outlay by 33 percent to ₹10 lakh crore, the highest ever to boost infrastructure, manufacturing and more. What pleased the experts further was that despite the increase in investment, the government maintained its fiscal deficit target at 6.4 percent for FY23 and reduced it to 5.9 percent for FY24.

Let's take a look at the different good news and bad news for the HNIs

Good News

The major announcement for HNIs was the reduction in the highest surcharge rate to 25 percent from 37 percent under the new tax regime for individuals with income above ₹5 crore. This will come into effect from April 1, 2023.

In her 2023-24 budget speech, Sitharaman said the highest tax rate in the country is 42.74 percent.

"This is among the highest in the world. I propose to reduce the highest surcharge rate from 37 percent to 25 percent in the new tax regime. This would result in a reduction of the maximum tax rate to 39 percent," Sitharaman said.

As per the current rates, a 10 percent surcharge is levied on individuals with income between ₹50 lakh and ₹1 crore, 15 percent on individuals with income between ₹1 crore to ₹2 crore, 25 percent on individuals with income in the range of ₹2 crore to ₹5 crore, and 37 percent in case the income is above ₹5 crore.

The Budget has now done away with the 37 percent surcharge under the new tax regime. All individuals with income above ₹2 crore will now have to pay a 25 percent surcharge on income tax.

This announcement is mainly to encourage high-income and high-net-worth individuals to also shift to the new tax regime.

“It is a nudge by the government to make high net worth individuals, or HNIs, adopt the new tax regime, which is clearly more beneficial for them," said Saraswathi Kasturirangan, partner at Deloitte India.

READ MORE: Modi’s Budget Woos Indian Middle Class, Women Ahead of 2024 Poll

Bad News

While the reduction in surcharge on income tax for HNIs is major good news. There are also some announcements that were not cheered by the HNIs.

1) The Union Budget for 2023-24 announced that the capital gains on market-linked debentures (MLDs) will now be taxed as short-term capital gains. They are currently being taxed as a long-term capital gain at the rate of 10 percent without indexation.

As per the Finance Bill, a special provision for the taxation of capital gains has been introduced in the case of Market Linked Debentures.

In the Budget 2023, Finance Minister Nirmala Sitharaman said that it has been noticed that a variety of hybrid securities that combine features of plain vanilla debt securities and exchange-traded derivatives are being issued through private placements and listed on stock exchanges. “It is seen that such securities differ from plain vanilla debt securities,” she said. Further, they give variable interests as they are linked with the performance of the market.

Further, it is also proposed to define the 'Market linked Debenture' as a security by whatever name called, which has an underlying principal component in the form of debt security and where the returns are linked to market returns on other underlying securities or indices and include any securities classified or regulated as a Market Linked Debenture by Securities and Exchange Board of India. This amendment will take effect from April 1, 2024.

Experts believe that the taxation change for MLDs to short-term capital gains will negatively impact HNIs and family offices, especially those who invest in MLDs for tax benefits since it effectively means that MLDs will now be taxed at a higher rate.

"MLDs have been popular investment products among HNIs and family offices given the preferential tax rate. Given the insertion of the above provision in the IT Act, the attractiveness of MLDs as an investment product will diminish significantly. Mutual funds are likely to benefit given that they continue to enjoy long-term capital gains tax treatment with indexation benefit,” said Vishal Chandiramani, Managing Partner-Products and Chief Operating Officer, TrustPlutus Wealth.

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2) Another announcement that is likely to negatively impact the HNIs is the proposal that long-term capital gains from house property in excess of ₹10 crore will not be exempt from tax even if it is reinvested in new house property.

"For better targeting of tax concessions and exemptions, I propose to cap deduction from capital gains on investment in residential houses under sections 54 and 54F to ₹10 crore," Finance Minister Nirmala Sitharaman said in her budget speech.

The existing provisions of section 54 and section 54F of the Income-tax, 1961 allow exemption on capital gains from the sale of a residential property and any other capital asset respectively. The exemption on the capital gain in the earlier provisions is allowed if the capital asset sold should have been held for over three years and the proceeds are used to purchase any residential property in India within a specified time period. These sections were mainly introduced to boost the housing space in the country.

The government has now limited the maximum exemption that an individual can get from the above sections to ₹10 crore.

“It has been observed that claims of huge deductions by high-net-worth assessees are being made under these provisions, by purchasing very expensive residential houses. It is defeating the very purpose of these sections," said the finance minister.

The cap of ₹10 crore will now also be applicable on deposits in the Capital Gains Account Scheme, which allows individuals to park their capital gains in a separate account until it is reinvested.

READ MORE: 5 opinions on the announcements made by FM Nirmala Sitharaman

3) Another announcement that will impact the HNIs is the removal of income tax exemption from proceeds of insurance policies in certain cases. “(A) proposal…is to limit income tax exemption from proceeds of insurance policies with very high value,” Sitharaman said.

In the FY24 Budget, the government announced that income earned from all life insurance policies, excluding unit-linked insurance plans (ULIPs), with a premium of above ₹5 lakh will be taxable. This is applicable for new policies, issued post April 1, and not for the existing ones. The government has basically taken away tax exemptions from traditional insurance plans if the annual premium is above ₹5 lakh. However, this does not apply to proceeds received on account of the death of the policyholder.

The government observed that the welfare objective of insuring the individuals’ life was misused, and large sums were received by HNIs. Therefore, to curb the misuse now, if the aggregate annual premium paid on life insurance policies goes beyond ₹5 lakh, the proceeds will no longer be exempted under the Act.

READ MORE: Women in Budget 2023: Government takes steps to empower women economically

Expert Views

"At an overall level, the Budget is quite positive for the HNIs due to the reduction in the highest income tax rate from 42.74% to 39%. This would see increased adoption of the new tax regime for individuals. Particularly, the high-income bracket founders and professionals will save taxes on their ESOPs. On the other hand, there are a few negative announcements that will impact HNIs and family offices such as the taxability of market-linked debentures as short-term capital gains and taxation of proceeds of high-premium insurance policies. A very significant change is in limiting the exemption provided for capital gains upon the purchase of a new residential property. If proceeds received from offers for sale by selling shareholders in an IPO are invested in purchasing a residential property beyond INR 10 cr, then the capital gains exemption will be available only in the proportion that INR 10 cr bears to the total proceeds of the share sale," said Vaibhav Gupta, Partner, Dhruva Advisors.

Nangia Andersen India Partner Neeraj Agarwal said for high net-worth individuals, the proposed budget amendments may say to be bittersweet. While on one hand, the percentage of surcharge on income above ₹5 crore, which has been reduced by a whopping 12 percent to 25 percent, has been welcomed with open arms, the cap on capital gain tax benefit by way of investment in a new residential property under section 54 and section 54F may prove expensive.