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Bonds have long been a preferred financial instrument for both individual and institutional investors. These fixed-income instruments offer stability and are also less risky compared to other investment options. However, investors finding comfort from market volatility by investing in bonds must understand their taxation. In this article, learn about the taxation of bonds in India and the points you need to note before investing in them.
Key Takeaways
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Interest earned on bonds is taxed as per the investor’s income tax slab, while capital gains tax depends on the bond type and holding period.
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Listed and unlisted bonds follow revised long-term and short-term capital gains.
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Tax-free bonds exempt interest income, but capital gains may still be taxable.
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Understanding TDS, exemptions, and bond categories helps improve post-tax returns.
What are Bonds?
A bond is a debt instrument through which a company or government borrows money from you, an investor. In return, they provide interest on the principal amount. The maturity date of the bond will be provided on the bond at the time of purchase. You can earn income on bonds through interest and capital gains. Interest is the amount provided at regular intervals based on the discussed percentage of the principal amount. Capital gains are the profits generated on selling the bonds post-maturity.
Taxation of Bonds in India
Bonds are taxed in India depending on two key factors, i.e., the type of bond and its holding period. Both interest and capital gains on bonds are taxed as below:
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Interest: Bond interest is added to your overall income and taxed at the applicable rate. If you submit your PAN, most bonds will have TDS deducted at 10%, unless Form 15G/15H is filed to avoid TDS.
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Capital gains: The capital gains on the bonds are taxed depending on the type of bond:
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Unlisted bonds
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Profits on unlisted debentures/bonds are treated as STCG and taxed at your slab rate, regardless of holding time. Indexation advantages are unavailable.
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The previous law of LTCG after three years is no longer applicable to most unlisted bonds.
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Listed bonds
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Long-term capital gains (LTCG) are taxed at a fixed 12.5% rate (no indexation).
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If held for one year or less, gains are subject to STCG and taxation in accordance with your income tax bracket.
Types of Bonds in India and Their Taxation
1. Regular Taxable Bonds
As the name suggests, these are taxable bonds. The interest earned on these regular taxable bonds is taxed as per the income tax slab of the investor and the capital gains tax levied on these bonds depends on the holding period of the bond. For example, you invested ₹5,00,000 in a taxable listed bond at a 10% interest rate and the maturity is 5 years. In this case, you earn ₹50,000 per annum as interest, which is added to your total income and taxed as per the income tax slab. In the case of capital gains, the taxation of listed bonds varies according to the holding period. If the maturity value of the bond is ₹6,00,000, the capital gains are ₹1,00,000. As this is a listed bond that has been held for more than a year, the gains of ₹1,00,000 are taxed at 10% without an indexation benefit.
2. Tax-Free Bonds
Public Sector Undertakings (PSUs) and the government issue tax-free bonds. The amount raised from these bonds is used to fund projects like railways, highways, rural and urban development, etc. The interest earned on these bonds is not taxed. However, the capital gains from these bonds are taxed as per the holding period, LTCG or STCG.
3. Tax-Saving Bonds
As the name suggests, these bonds help investors save taxes. Tax-saving bonds are issued by the Government of India. The interest rate on these bonds is decided by the Indian Government and they come with a minimum lock-in period of 5 years. The interest income on the tax-saving bonds is taxable as per the income tax slab of the investor. The capital gains are taxed depending on the holding period, which is LTCG, as there is a lock-in period on these bonds. You can claim a tax deduction of up to ₹20,000 on your investment made on tax-saving bonds, under section 80CCF. These tax-saving bonds are beneficial for individuals with long-term capital assets. As per Section 54EC, if you have long-term assets like buildings, land or both, you can save on 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 6 months from the date of the transfer of the asset.
- The gains are invested in bonds issued by the National Highway Authority of India (NHAI), Rural Electrification Corporation (REC), Indian Railway Finance Corporation (IRFC) or Power Finance Corporation Limited (PFC).
- The maximum investment amount should be less than ₹50 lakh.
4. Zero-Coupon Bonds
The interest earned on a bond is known as a coupon. Zero-coupon bonds are the bonds that do not provide interest on the bonds. But these bonds are issued at a discount. However, on maturity, the investor gets the entire face value of the bond. For example, if you have invested in a zero coupon bond with a face value of ₹25,000. The issue price is ₹10,000. This means that you got a discount of ₹15,000. Upon maturity of the bond, you will receive the full amount of ₹25,000. As there is no interest, there are no taxes levied. The capital gains you receive on these bonds are taxed as per the holding period. Rural Electrification Corporation (REC), NABARD, etc., issue these bonds.
5. Sovereign Gold Bonds (SGB)
These government-backed bonds allow investors to invest in gold without buying physical gold. SGBs are issued by the Reserve Bank of India (RBI) and are denominated in grams of gold. SGBs not only offer capital gains but also a fixed interest of 2.5% per annum on the initial investment, which is paid half yearly. These bonds are subject to fluctuations according to the gold rates. These bonds come with a maturity period of 8 years. However, you can exit the bond after 5 years only on the interest payout dates. Regarding taxation, here are some things to keep in mind:
- The interest earned on these gold bonds is taxed as per your income tax slab.
- Capital gains earned by these bonds are taxed based on the holding period. If held till maturity, the capital gains from these bonds are exempted from taxes. However, LTCG are taxed at 20% with an indexation benefit if they are sold after 5 years and before 8 years of the purchase date.
Here’s a table to understand the taxation of bonds in India, clearly.
| Bond Type | Taxation on Interest | Taxation on Capital Gains |
| Regular Taxable Bonds | Taxed as per income tax slab |
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| Tax-Free Bonds | Interest income not taxed | Taxed based on the holding period. |
| Tax-Saving Bonds | Taxed as per income tax slab | Taxed based on the holding period. Investment can be claimed for deduction under Section 80CCF, up to ₹20,000. |
| Zero-Coupon Bonds | No interest, no taxes | Taxed based on the holding period. |
| Sovereign Gold Bonds (SGB) | Taxed as per income tax slab | Exempted from tax if held till maturity. LTCG tax of 20% with indexation benefit is applicable if sold after 5 years but before 8 years. |
TDS on Bonds
Under the Taxation of Bonds in India, interest income earned from bonds is subject to Tax Deducted at Source (TDS) as per Section 193 of the Income Tax Act, 1961. TDS is generally deducted at a rate of 10% on interest payments for both listed and unlisted bonds if the interest exceeds the prescribed threshold. If an investor's income is less than the taxable limit, they can submit Form 15G/15H to avoid paying TDS.
The deducted amount is reflected in the investor’s Form 26AS and can be adjusted against the final tax liability while filing income tax returns. If an investor’s total income is below the taxable limit, they may submit the relevant declaration to avoid TDS deduction. Sovereign Gold Bond interest does not attract TDS.
Conclusion
Bonds offer stable returns and are less risky investments. However, it is important to note the taxes involved in the bonds, which can impact your final returns. Talk to your financial advisor before making any decision. Use Angel One app to explore other investment options like stocks, mutual funds, etc. Open a Demat Account on Angel One for free today.
