Taxation Of Bonds
Many investors have relied on Bonds as a financial instrument to invest securely for a longer period. These fixed-income instruments provide stability and are relatively risk-free compared to other investment options. Investors consider several factors when allocating their money to bonds, such as coupon payments and closing times. However, the most important factor when investing in this investment is tax. In this article, we will explore the taxation of bonds in India and other important factors to check before investing.
Key Highlights
- Bonds are taxed differently in India based on their type and holding period. The government considers both capital gains and interest income when taxing bonds.
- Unlisted bonds held for over three years face a 20% Long-Term Capital Gains tax, while those held for less time are taxed according to the investor’s income tax slab.
- Listed bonds kept for more than a year incur a 10% Long-Term Capital Gains tax.
- Shorter holding periods result in taxation based on the investor’s income tax bracket.
- Tax-free bonds, issued by the government and public sector companies, offer completely tax-exempt interest income. However, capital gains from these bonds may still be taxable.
- Tax-saving bonds allow investors to claim deductions up to ₹20,000 under Section 80CCF.
Taxation of Bonds in India
A bond is a debt instrument that an organization or government issues to borrow money from an investor. In return, the issuers of the bonds offer certain interest on the principal amount. The maturity date of the bond is addressed to the bondholder during the time of purchase of the bond.
Investors need to be aware that different types of bonds are taxed differently. Bonds are taxed in India based on two key elements. This includes the type of bond and its holding time. The interest and capital gains on bonds are taxable. The following is the breakdown of how these factors are taxed:
- Capital gains: The capital gains at the bonds are taxed according to the type of bond.
- Interest: The interest rates on bonds are taxed as per the income tax slab of an individual. This is done by adding interest income to one’s total income.
There are two common categories of bonds. The following is the breakdown of how taxation of bonds is levied in these categories:
- Unlisted bonds: Gains on those bonds that are held for more than three years are considered Long-Term Capital Gains (LTCG). These are taxed at 20% without the benefit of indexation. The potential gains from bonds that are held for less than three years are considered Short-Term Capital Gains (STCG). The tax on bonds of such category is usually levied as per one’s income tax slab.
- Listed bonds: Listed bonds held for more than 12 months i.e. one-year experience LTCG bonds tax at 10% without an indexation benefit. The listed bonds held for less than 1 year are considered STCG, and it is taxed according to one’s income tax slab.
Types of Bonds in India and Their Taxation
The following is the breakdown of how the tax on bonds is levied on different types of bonds:
| Bond Type | Interest Tax | Capital Gains Tax |
| Regular Taxable Bonds | Tax slab rate applies | Listed: 10% for long-term, as per tax slab for short-term. Unlisted: 20% for long-term, as per tax slab for short-term |
| Tax-Free Bonds | No tax on interest | The tax depends on how long you hold the bond |
| Tax-Saving Bonds | Tax slab rate applies | The tax depends on holding time. You can claim up to ₹20,000 deduction under Section 80CCF |
| Zero-Coupon Bonds | No interest, no tax | Tax based on the holding period |
| Sovereign Gold Bonds | Tax slab rate applies | No tax if kept until maturity. 20% tax with indexation if sold after 5 years but before 8 years |
Let’s understand in detail how all the listed types of bonds are taxed. This helps you make better selections of investment as per your financial capability, goals and risk tolerance.
- Regular Taxable Bonds
Regular taxable bonds are taxable on the interest earned by the bonds as per the investor’s income tax slab rate. Other than that, the capital gains tax on this type of bond depends on the holding period of the bonds.
For example, suppose you invested ₹8,00,000 in a taxable listed bond with an interest rate of 10% and a maturity of 5 years. In this case, you get ₹80,000 per year as interest. This interest amount is then further added to your total and taxed as per your income tax slab.
This way, here, for capital gains, the tax rate on listed bonds varies as per holding period. If the maturity value of the bond is ₹9,00,000, the capital gains will be ₹1,00,000. As it is a listed bond held for more than 12 months, the capital gain of ₹1,00,000 is taxed at 10% without benefit of indexation.
- Zero-coupon Bonds
The interest rate on a bond is known as a coupon. Zero-coupon bonds are bonds that pay no interest on the bonds. However, these bonds are issued at a discount and during maturity, the investor receives the full principal amount of the bond.
For example, if you have invested in a zero coupon bond of ₹45,000. The issue price of the bond is valued at ₹20,000. This means you got a discount of ₹25,000. Once the bond matures, you will get the full amount of ₹45,000.
As there’s no interest, these bonds are not taxable. The capital gains you make on these bonds are taxed according to the holding period. Rural Electricity Corporation (REC), NABARD etc. usually issue these types of bonds.
- Tax-free Bonds
Governments and Public Sector Undertakings (PSUs) issue these types of bonds to raise funds for various projects of the country’s growth and development. The government raises finances through tax-free bonds to fund infrastructure and social welfare projects like highways, railways, urban and rural improvement, etc.
Investors do not pay any tax on interest earned from tax-free bonds, as the name itself suggests that these bonds are tax-free. However, returns earned from such bonds upon maturity or sale are categorized under LTCG and STCG. The categorisation depends on the holding period.
- Sovereign Gold Bonds
Sovereign gold bonds are government-backed bonds that permit investors to put money into gold without buying a physical form of gold. These bonds are issued via the Reserve Bank of India (RBI) and are denominated in grams of gold. Sovereign gold bonds offer a fixed interest rate of 2.5% per annum on the initial investment as well as capital gains. These bonds may fluctuate as gold rates keep on fluctuating.
These bonds usually come with a maturity period of 8 years. However, you may exit from the bond after 5 years only on interest payout dates. Furthermore, one needs to consider the following pointers regarding the taxation of bonds:
- The interest earned on these gold bonds is taxed in keeping with your income tax slab.
- Capital gains earned via these bonds are taxed based totally on the holding period. If you held these bonds till maturity, the capital gains from those bonds are exempted from taxes. However, LTCG are taxed at 20% with an indexation benefit if they may be sold after five years and before eight years of the buying date.
- Tax-saving Bonds
Tax-savings bonds assist investors to save on bonds tax. The Government of India issues tax-saving bonds. The interest rate on these types of bonds is decided by the Indian Government and it has a lock-in period of a minimum of five years.
The interest gains on the tax-saving bonds are taxable as per the investor’s income tax slab. The capital gains are taxed as per the holding period. One can claim a tax deduction of up to ₹20,000 on tax-saving bonds, under section 80CCF.
These tax-saving bonds are beneficial for investors with long-term capital belongings. As in line with Section 54EC, when you have long-term assets like buildings, land or both, investors can save on the taxes arising on the capital gains from the transfer of these assets if,
- The capital gains from the long-term assets are invested in tax-saving bonds within six months from the date of the asset’s transfer.
- The capital gains are invested in bonds issued by the National Highway Authority of India (NHAI), Indian Railway Finance Corporation (IRFC), Power Finance Corporation Limited (PFC) or the Rural Electrification Corporation (REC).
- The maximum amount needs to be less than ₹50 lakh.
Conclusion
One needs to understand how bond taxes affect different types of bonds, to make smart investment choices. Regular taxable bonds mean that you have to pay taxes on the interest income and the sale proceeds. A tax-free bond is not taxable on the interest earned. However, if you sell the bond and make a profit, that profit (capital gain) is subject to tax. And so different bonds are taxed on different aspects. Before investing, read and research each bond thoroughly. This will help you to select the type of bonds that accomplish your financial targets. If you are stuck between the investment decision or any concerning factors that need sound assistance, you may take the help of financial experts.