Taxation on Bonds in India

Fixed-income investments like bonds have always been popular among conservative investors looking for steady returns with lower risk. However, understanding the taxation of bonds is essential to evaluate their actual returns. The Indian tax system has specific rules for different types of bonds, and knowing these can help you make informed investment decisions. This article covers the key aspects of taxation on bonds in India.

Understanding the Basics of Bonds

Bonds in India are defined as debt instruments that governments, municipalities, or companies issue to raise capital for different purposes. Through investment in bonds, you lend a given sum of money to the issuer. In exchange for this investment, you will get regular payments at a fixed interest rate and the return of the principal amount at maturity.

The returns from bonds come in two forms:

• Interest income earned periodically
• Capital gains (when you are able to sell the bond at a price higher than the purchase price)

Both these components have different rules for taxation of bonds that investors need to understand.

How Taxation of Bonds Works in India?

The taxation of bonds in India follows certain principles that vary based on the bond type and holding period. The tax liability primarily covers two aspects: interest income and capital gain. 

Here is how each component is taxed:

Taxation of Interest Income

Interest earned from most bonds is fully taxable and added to your overall income, which is then taxed according to your applicable income tax slab rate. This applies to most coupon bonds available in the market. The interest is typically paid out periodically, often every six months.

For certain bonds, Tax Deduction at Source (TDS) applies to interest earnings at a rate of 10% if the interest amount exceeds ₹10,000 in a financial year. In the absence of PAN, TDS would be deducted at 20%.

Taxation of Capital Gains

Capital gains tax on bonds in India depends on the holding period of the bond and whether the bonds are listed or unlisted:​

Listed Bonds

• Short-Term Capital Gains (STCG): For listed bonds held for 12 months or less, the short-term capital gains are added to the investor’s total income and taxed according to their income tax slab rates.
• Long-Term Capital Gains (LTCG): For listed bonds that are held beyond a period of 12 months, such gains are categorised as long-term.
  • Such gains are taxable at a flat rate of 12.5%, without indexation benefits. 
  • An exemption of up to ₹1.25 lakh is available on such gains for every financial year. ​

Unlisted Bonds

• Gains from unlisted bonds, regardless of the holding period, are taxed according to the investor’s applicable income tax slab rate. This rule applies to transfers, redemptions, or maturities occurring on or after July 23, 2024. 

Types of Bonds and Their Tax Implications

Different types of bonds available in the Indian market come with varying tax treatments:

Government Bonds

Government bonds like Government Securities (G-Secs) and Treasury Bills are low-risk investments issued by the central or state governments. The interest earned is fully taxable at your income tax slab rate. However, no TDS is deducted. Taxation of capital gains depends on the holding period. Short-term gains are taxed at the slab rate, while long-term gains are taxed at 12.5% without indexation if held for more than 12 months.

Corporate Bonds

Corporate bonds are issued by companies to raise capital (usually) for expansion and development initiatives. Both listed and unlisted corporate bonds are subject to a 10% TDS on interest income. Capital gains on these bonds are also taxed, depending on the duration of the holding period.

Tax-Free Bonds

Some bonds issued by government entities are exempt from tax on the interest component under Section 10 of the Income Tax Act. However, capital gains on these bonds when sold before maturity are still taxable. If you sell the bond within one year, the resulting capital gains are taxed according to your applicable income tax slab. However, if the bond is sold after a holding period of more than one year, the gains are treated as long-term and taxed at a flat rate of 10% without the benefit of indexation.

Capital Gain Bonds (Section 54EC Bonds)

These are long-term bonds issued by infrastructure finance companies. They provide a way to save tax on long-term capital gains from the sale of property and offer tax exemption benefits under Section 54EC of the Income Tax Act. If you have earned long-term capital gains from property and invested in these bonds within six months of the sale, you can claim exemption from the capital gains tax, subject to a maximum limit of ₹50 lakhs.

Zero-Coupon Bonds

Zero-coupon bonds are issued at a discount and redeemed at face value, without any periodic interest payments. For notified zero-coupon bonds (e.g., issued by NABARD, REC, etc.), the difference between purchase price and maturity value is treated as capital gains and taxable in the same way as corporate bonds. The capital gains from these bonds are taxed at 10% without indexation if held long-term and as per the investor’s tax rate if held for less than a year. For non-notified bonds, the difference is taxed as regular interest income at slab rates.

Foreign Bonds

Foreign bonds are issued by overseas entities and expose investors to global markets. In India, both interest income and capital gains from these bonds are taxable. TDS is applicable as per the tax treaty between India and the country of issuance. Additionally, investors may face TDS in the foreign country, but they can claim tax benefits under the Double Taxation Avoidance Agreement (DTAA).

Final Words

The taxation of bonds in India has various nuances that investors should understand before investing. Tax implications differ based on the bond type, issuer, and your holding period. While some bonds offer tax benefits, others are fully taxable. By understanding these aspects, you can make more informed investment decisions and potentially enhance your after-tax returns.

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