Bonds without concessions: how will the change in taxation affect the debt market?

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In 2022, bonds in Russia lost their special tax status, and investor income was included in the base for calculating personal income tax on a new progressive scale . How will this affect the market?

If defensive assets are chosen, bonds will continue to be in demand, but after such changes, the broad interest of new market participants will be even more directed to riskier and potentially more profitable assets.

New Approach

Prior to the introduction of amendments to the Tax Code, the income of private investors from investments in bonds was taxed depending on the date of issue of securities and their type. At the same time, coupon income on federal debt securities (OFZ) was completely exempt from taxation. The same exemption was valid for corporate bonds issued after 2017, with a coupon rate no more than 5 percentage points higher than the key rate of the Central Bank of the Russian Federation. From the excess of the coupon rate over the key rate of the Central Bank plus 5 percentage points, a tax of 35% was calculated. For securities issued before 2017, the flat rate was 13%. Non-residents will continue to pay 30%, previously they also had an exemption under OFZ.

From 2021, both coupon income and income from the increase in the value of debt securities are taxed at a single rate of 13%. If the total amount of income exceeds 5 million rubles, the rate on the excess amount will be 15% – a combined tax will be calculated. The new scale also applies to other types of income of individuals: wages, dividends, income from bank deposits, and so on.

Due to changes in the market, interest has grown in ways to minimize additional deductions. One way is to invest through a special individual investment account (IIA) and not withdraw assets from it for at least three years. This approach can allow you to take advantage of two types of benefits: to receive a tax deduction from previously paid personal income tax or to exempt income received from investment from tax.

Another method is investing in bonds through traded mutual funds. Income for a private investor arises when a share is sold, and not every time a coupon is accrued or the management company makes transactions with securities from the fund’s portfolio.

In both cases, investors should pay attention to fees for opening and maintaining accounts, making transactions and managing funds. Despite the downward trend in commissions in the market, such deductions can significantly affect the final net income, since interest income levels in the safe debt segment are quite low.

Where are investors looking?

For a long period of time, the number of retail investors in the Russian stock market practically did not grow and was at a low level, amounting to several hundred thousand participants. This hindered the development of the market. To stimulate the inflow of new funds, tax incentives were introduced.

It is often with the purchase of bonds that investors begin their work in financial markets. Against the backdrop of a downward trend in yields on bank deposits, bonds really began to attract more and more private investors, which was also facilitated by the tax factor. According to the head of NAUFOR Alexey Timofeev, about 60% of the portfolio of retail investors is invested in various types of bonds.

What’s next?

The tax changes were known in advance, and this factor has already been partially taken into account by the market in 2020. Combined with a period of low base rates in Russia and around the world, federal and first-tier bonds lost their appeal to retail investors in the moment.

However, there is no alternative among reliable assets – income on deposits also fell under taxation and is at low levels. In February, the market intensified discussion of a possible tightening of the Central Bank’s monetary policy. After two years of rate cuts, the regulator sends a signal to stop the trend. The Central Bank of the Russian Federation  does not rule out an increase in the key rate. The global trend to keep rates low until the pandemic is over and the economy recovers has not yet changed. However, in the US, battles between the parties of the policy of enhanced economic stimulus and those who are unprofitable for the unfolding of inflation against the backdrop of near-zero yields have begun. Verbal intervention has already affected bond quotes in all markets, and it is possible that this will become a frequent occurrence in the coming year.

Theoretically, the demand for OFZ from individuals could decrease due to changes in legislation, but it should be borne in mind that the tax is also introduced for bank deposits. At the same time, the payment of tax can be avoided if the investor purchases shares of mutual funds that use OFZ as the underlying asset. Therefore, demand, most likely, will only flow from direct ownership of OFZs to indirect ownership.

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