Taxation on Bonds: Everything You Need to Know

Understanding how bond investments are taxed is essential for every investor, whether they are salaried professionals or self-employed individuals. This guide explores the various tax implications associated with interest income and capital gains from different types of bonds in India, helping readers make informed financial decisions.

Bonds are fixed-income financial instruments where an investor lends money to a government or corporation for a set period at a fixed interest rate. In return, the issuer promises to pay regular interest (called coupon payments) and return the principal at maturity.

They are considered relatively safer than stocks and are often used for steady income and portfolio diversification.

Bond taxation refers to the levies applied on earnings from bonds, which may include interest income or profits from selling the bonds. The tax treatment depends on several factors such as the type of bond, holding period, and the investor's residential status.

Bond earnings fall into two main categories:

• Interest income: Periodic earnings received by bondholders.
  

• Capital gains: Profits from the sale of bonds before maturity.
  

Investors must also be aware of regulatory classifications:

• Listed bonds: Traded on stock exchanges.
  

• Unlisted bonds: Not traded publicly.
  

• Tax-free bonds: Interest is exempt under specific sections.
  

• Zero-coupon bonds: Do not pay periodic interest; sold at a discount.

1. Government Securities (G-Secs)
Issued by the central and state governments—very low risk with semi-annual interest payouts

2. Corporate Bonds
Issued by companies; available as convertible (convert to equity) or non-convertible bonds
Typically offer higher interest than G-Secs due to slightly higher risk.

3. Tax-Free Bonds
Issued by PSUs or government bodies; interest income is completely tax-exempt

4. Tax-Saving Bonds (Section 80CCF/54EC)
Designed to save tax; principal may be deductible, but interest is taxable

• 54EC Bonds: Help defer capital gains tax from selling property; 5-year lock-in; interest earns ~5.75% p.a.

5. Zero-Coupon Bonds
Issued at discount; no regular interest; full face value paid at maturity

6. Inflation-Indexed Bonds
Principal and interest adjust for inflation, protecting against price rise

7. Sovereign Gold Bonds (SGBs)
Government-issued; pay fixed interest plus gold price-linked gains; interest taxable, but long-term capital gains are often exempt

8. Municipal Bonds
Issued by city bodies; interest income is generally tax-free; used to fund public projects

Selling bonds before maturity can result in capital gains, and the tax treatment depends on whether the bond is listed or unlisted, the holding period, and the date of redemption.

• For bonds redeemed before 23rd July 2024:

  • Listed Bonds

    • Short-Term Capital Gains (STCG): If held for less than 12 months, gains are taxed as per the investor's income tax slab.

    • Long-Term Capital Gains (LTCG): If held for 12 months or more, gains are taxed at 10% without indexation.

  • Unlisted Bonds

    • STCG: Gains from bonds held for less than 36 months are taxed as per slab rates.

    • LTCG: Gains from bonds held for 36 months or more are taxed at 20% with indexation.

• For bonds redeemed on or after 23rd July 2024:

Both short-term and long-term capital gains on bonds are taxed as per the investor's applicable income tax slab rates, regardless of holding period or whether the bond is listed or unlisted. This is a significant change introduced by the Finance Act 2024.

Suppose an investor buys a listed bond for ₹1,00,000 and sells it for ₹1,10,000 after 14 months.

• If sold before 23rd July 2024, the ₹10,000 gain is considered LTCG and taxed at 10% without indexation.

• If sold on or after 23rd July 2024, the ₹10,000 gain will be added to the investor’s total income and taxed as per the applicable income tax slab.

Section 54EC of the Income Tax Act allows exemption on LTCG from sale of property if the proceeds are reinvested in specified bonds.

• Eligible bonds: REC, NHAI, PFC
  

• Maximum investment: ₹50 Lakhs per financial year
  

• Lock-in period: 5 years
  

• Interest: Taxable
  

• Exemption: On amount invested in 54EC bonds, subject to conditions

TDS, or Tax Deducted at Source, is applicable to interest earnings above a specified threshold.

• TDS applies if interest exceeds ₹5,000 in a financial year (threshold may vary based on government notifications and senior citizen status)
  

• TDS rate: 10% (with PAN); 20% (without PAN)
  

• No TDS on tax-free bonds
  

• For NRIs, TDS is applicable at a flat rate as per relevant tax treaties
  

1. For NRIs, bond taxation is governed by both the Income Tax Act and FEMA (Foreign Exchange Management Act).

   • Interest income: Taxed at a flat 20% plus surcharge and cess
     

   • TDS: Applicable at source; DTAA provisions may allow lower rates
     

   • Capital gains:
     

     • Listed bonds: LTCG @10%
       

     • Unlisted bonds: LTCG @20%
       

     • STCG: As per slab

Understanding how bonds are taxed helps investors anticipate their post-tax returns more accurately. By considering the type of bond, holding period, and applicable sections under the Income Tax Act, individuals can ensure tax compliance and effective portfolio management.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

• Securities and Exchange Board of India (SEBI): https://www.sebi.gov.in/

• Income Tax Department: https://www.incometaxindia.gov.in/

• Reserve Bank of India (RBI): https://www.rbi.org.in/