In India, bonds are financial instruments that are used to raise capital by companies, financial institutions, and government entities. They are essentially debt instruments that provide a fixed rate of return to the investor.
Under the Indian Income Tax Act, the interest income earned on bonds is treated as taxable income and is subject to tax at the applicable rate. The interest income earned on bonds is added to the total income of the individual or entity and taxed accordingly.
However, there are certain types of bonds that are exempt from tax under the Income Tax Act. For example, interest earned on government securities, such as the National Savings Certificate (NSC), Kisan Vikas Patra (KVP), and Public Provident Fund (PPF), are exempt from tax.
In this article, we will discuss about Taxation on Gains from Bond Investment in India.
Taxation on Gains from Bond Investment in India
Bond investors check many parameters while investing in bonds, such as a coupon, frequency of coupon payments, maturity & yield. Important factor to be considered in bond investment is “taxation on gains from bond investment. Few important points that need to be considered before taxation on gain from bond are:
- Bonds provide coupon payments and return principal amount on maturity. Firstly, the coupon payments 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 are Listed Bonds, and bonds that are not listed on the National Stock Exchange are called Unlisted Bonds.
- Short Term Capital Gain Tax is applicable if you sell listed bonds before 12 months (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.
- TDS will not be deducted on interest received from Listed Bonds & Debentures.
- Slab system defines the tax rate applicable to individuals considering age and income. Individuals can be Resident or Non-Resident or HUF or Association of Person (AOP) or Body of Individual (BOI) or any other Artificial Juridical Person (AJP). The applicable tax rate is called the slab rate.
Taxation of bonds in India as follows
1. Regular Taxation of Bonds in India – 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 be 5% to 30%.
Example – Mr. Suresh is a senior citizen aged 65. He has invested Rs. 10 lakhs in listed bonds. The coupon rate, i.e., interest rate, is 10% paid annually. His annual income is 9 lakhs. So, he comes under the 20% slab rate
Investment amount – 10,00,000
Coupon rate -10%
Annual Interest income – 1,00,000
Tax on interest income:- 1,00,000 * 20% = Rs 20,000
Suresh has to pay Rs. 20,000 taxes on interest income every year till maturity or till he resells bonds
STCG Tax – Suppose after 10 months, if he sells bonds for Rs.10,50,000, then the capital appreciation is Rs.50,000
Tax on STCG – 20% X 50,000 = Rs 10,000
LTCG Tax – Suppose after three years, if he sells bonds for Rs. 13,00,000, then the capital appreciation is Rs. 3, 00, 000
Tax on LTCG – 10% X 3,00,000 = Rs 30,000
Note –
i) Indexation benefits can be availed only in the case of inflation-indexed bonds or capital indexed bonds.
ii) The income should be listed under the ‘income from other sources’ section in your income tax forms
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.
Tax Saving Bonds
Section 54EC Bonds are Capital Gain Tax Exemption Bonds that provide 100% tax exemption on the long-term capital gain earned by selling any property. These bonds are the best options to save tax after the 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 Section 54EC Bonds is 50 lakhs.
Section 54EC Bonds do not provide any exemption on short term capital gains.
Note –
i) Interest earned on tax exemption bond will be taxable as per the slab rate of the individuals. Income should be listed under the ‘income from other sources’ section in your income tax forms.
ii) There is a lock-in-period of 5 years on these exempted 54EC bonds from the date of purchase of bonds, if these bonds are sold before 5 years from date of purchase then the LTCG exempted earlier will be taxable in the hands of assessee. Even if any loan or security is taken against these bonds will be treated as redemption & LTCG exempted earlier will be taxable.
Example – An immovable property is sold at Rs. 85 lakhs after a period of 42 months from the date of acquisition. The indexed cost of acquisition is 52 lakhs and indexed cost of improvement is Rs. 13 lakhs. Calculate the capital gain that is taxable after claiming exemption under Section 54EC if investment amount is Rs. 22 lakhs invested in NHAI bonds within 6 months from date of sale of immovable property
| Particulars | Amount (Rs) |
| Sale Consideration | 85,00,000 |
| Less: indexed cost of acquisition | 52,00,000 |
| Less: indexed cost of improvement | 13,00,000 |
| Long Term Capital Gain | 30,00,000 |
| Less: Investment in NHAI Bonds | 22,00,000 |
| Taxable Long Term Capital Gain | 8,00,000 |
In case if the capital gain bonds are converted into cash before the lock-in-period of 5 years, then the amount so invested on which tax exemption was claimed, shall be taxable as long-term capital gain in the year of conversion. For example, in above case if the bonds are redeemed before the period of 5 years form the date of investment, then Rs. 22 lakhs allowed as exemption u/s 54EC shall be taxable as long-term capital gain in the year in which such contravention is done.
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.
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