Bond investors usually check many parameters while investing in bonds or debentures, such as a coupon, frequency of coupon payments, maturity, and yield. Another important factor to be considered in bond investment is taxation on gains from bond investments. 

 

Last week, we covered new-age bond platforms where investors can buy bonds. So this week, in our blog post, we will discuss this aspect keeping in mind current rules. Before we get into further details, let us look at a few basics. 

 

Slab Rate in Tax

 

The slab system defines the tax rate applicable to individuals considering age and income. Individuals can be resident or non-resident or Hindu undivided family (HUF). The applicable tax rate is called the slab rate. 

 

Tax deducted at source (TDS) is not be deducted on interest received from listed bonds and debentures.

 

Bonds provide coupon payments and return principal amount on maturity. Firstly the coupon payments (akin to interest income) are the gains from bond investment; hence they are taxable. Secondly, you may sell bonds in the secondary market before maturity, or you may hold bonds till maturity. In either of the cases, if there is capital gain, then the gains are taxable. 

 

The bonds listed on the National Stock Exchange (NSE) or Bombay Stock Exchange (BSE) are termed listed bonds, and bonds that are not listed on these exchanges are called unlisted bonds. 

 

Short Term Capital Gains/ Long Term Capital Gains

 

Short Term Capital Gain Tax is applicable if you sell listed bonds before 12 months (while it is 36 months in the case of unlisted bonds).

 

Long Term Capital Gain Tax is applicable if you hold listed bonds for more than 12 months or hold unlisted bonds for more than 36 months. 

 

The table below explains how gains will be taxed based on whether they are listed or unlisted and based on the period of holding.

 

 

Taxation on bonds in India varies based on the category of bonds.

 

1) Regular Taxable Of Bonds in India 

 

The interest earned from bonds is taxed as per marginal slab rate, and the maximum slab rate is 30%. Appreciation of the bond price is considered as capital gain and taxed accordingly. If these bonds are held for the long term (more than 12 months for listed bonds and more than 36 months for unlisted bonds), the capital gain tax will be 10 %. Short-term capital gain tax can range from  5% to 30% depending on your slab rate. 

 

Example: 

 

Mrs Radhakrishnan is a senior citizen aged 65. She has invested Rs10 lakh in listed bonds. The coupon rate, i.e., interest rate, is 10% paid annually. Her taxable annual income is 9 lakh. So, she comes under the 20% slab rate. 

 

Investment amount – 10,00,000 

 

Coupon rate -10%

 

Annual interest income – 1,00,000 

 

Tax on interest income: 

 

Tax – 20%X 1,00,000 

Tax- 20,000

 

Mrs Radhakrishnan has to pay Rs20,000 tax on interest income every year till maturity or till she sells those bonds. 

 

STCG:

 

After 10 months, if she sells bonds for Rs10,50,000, then the capital appreciation is  Rs50,000

 

Tax- 20% X 50,000

 

Tax – 10,000

 

Mrs Radhakrishnan has to pay Rs10,000 as short term capital gains tax. 

 

LTCG: 

 

After three years, if she sells bonds for Rs13,00,000, then the capital appreciation is Rs3, 00, 000. 

Tax – 10% X 3,00,000

 

Tax- 30,000

 

Mrs Radhakrishnan has to pay Rs30,000 as long term capital gains tax. 

The income should be listed under the ‘income from other sources’ section in your income tax return form. 

 

2) Tax-Free Bonds 

 

In the case of tax- free bonds, the interest earned from bonds is not taxed, but price appreciation of the bonds during maturity (or sale) is considered as capital appreciation. Hence capital gain taxes are applicable. Considering the holding period, either LTCG or STCG, will be applicable.  

 

3) Tax Saving Bonds 

 

54EC bonds are capital gain tax exemption bonds that provide 100% tax exemption on the long term capital gains earned while selling any property. These bonds are the best options to save tax after a property sale. But conditions apply, such as the time gap between property sale and bond investment cannot exceed six months. Also, the investment limit in 54EC Bonds is 50 lakhs. 54 EC Bonds do not provide any exemption on short term capital gains.

 

4) Zero-Coupon Bonds 

 

Zero-coupon bonds do not pay interest, but they are sold at a discount and return full face value on redemption. Investors of Zero-coupon bonds are subjected to capital gains tax only. Price appreciation during the sale or maturity is considered as capital gain and taxed accordingly.

 

Points to note:

 

Inclusion of accrued interest should not be missed while selling the bonds in the secondary market. During the calculation of capital gain tax, the inclusion of accrued interest reduces the capital gains hence can save capital gain tax.

 

Indexation benefits can be availed only in the case of inflation-indexed bonds or capital indexed bonds. 

 

Taxation is always a complicated process and bond investments do provide options to save tax. However, it is always advisable to seek advice from a chartered accountant or a tax consultant before investing in bonds and debentures.