Both institutional and retail investors often prefer investing in bonds because of their inherent stability and low-risk nature. However, many times, people are late in understanding the taxation of bonds in India, which often leads to complexities when calculating tax-exclusive returns. In this blog, we will cover this topic and also discuss some additional points to remember before you start investing in bonds.
How Are Bonds Taxed in India?
Two primary factors determine the taxation on corporate bonds in India. These include:
- Bond type
- Holding period
Depending on the above-mentioned parameters, TDS is charged on both capital gains and interest earned from bonds. You have to pay tax on the accrued interest as per your respective tax slab rate. To determine the percentage, you can add your yearly bond yield to your total annual income and accordingly, the TDS is calculated.
Next, the capital gains part attracts taxation based on the nature of the bond. These include:
Listed Bonds
If you hold units of a listed bond for less than a year, then you have to pay Short-term Capital Gains Tax according to your income tax slab. Contrarily, if you maintain your positions in listed bonds for over 1 year, you are taxed at 12.5%.
Unlisted Bonds
A LTCG tax rate of 12.5% is levied when you sell unlisted bonds in the market after holding for more than 12 months. On the other hand, if you decide to sell your possessions before 12 months from buying the bond then you are taxed as per your income tax slab.
Types of Bonds in India and their Tax Implications
Here’s a breakdown of common bond types and their tax implications:
Regular Taxable Bonds
As you invest in these bonds, your interest earnings are taxed according to your income tax slab. Additionally, a capital gains tax is imposed, and the rate varies based on the holding period of your bond investments.
Let us understand this with an example. Suppose, you invested ₹4 lakh for 5 years in a listed regular taxable bond offering 10% interest. Upon investment, your bank account will be credited with ₹40,000 interest every year throughout the investment tenure.
Moreover, the interest amount will be combined with your total annual income to determine your taxable income. The applicable income tax slab rates will then be used to calculate your tax liability.
Tax-Free Bonds
Several government entities and Public Sector Undertakings (PSUs) can issue tax-free bonds. Taxation is ignored on these bonds to encourage more investors to contribute to developmental projects like highways, urban and rural infrastructure and railways.
Although the interest earned from these bonds is tax-free as per Section 10(15) of the Income Tax Act, capital gains tax is still accounted for based on the period you hold your positions – either STCG or LTCG tax.
Tax-Saving Bonds
These bonds, issued by the Government of India, help reduce the overall tax liability of investors. They are offered with a minimum 5-year lock-in period and their interest rates are fixed by the Central Government.
You have to pay income tax on the interest gained from tax-saving bonds according to your income tax slab rate. Simultaneously, an LTCG tax is levied upon selling the bond after a 5-year lock-in period.
However, you may claim a tax rebate of up to ₹20,000 on your tax-saving bond investments. These instruments generally prove to be advantageous for people with long-term capital assets.
According to Section 54EC, when you own long-term assets such as a land, a building or both, you have the option to minimise your tax liabilities arising out of capital gains from selling such assets if:
- You invest those capital gains in tax-saving bonds within six months of the asset sale.
- You use the gains to purchase bond units offered by the Indian Railway Finance Corporation (IRFC), National Highway Authority of India (NHAI), Power Finance Corporation Limited (PFC) or Rural Electrification Corporation (REC).
However, remember that the maximum investable amount per financial year is capped at ₹50 lakh, irrespective of the method used.
Sovereign Gold Bonds (SGBs)
SGBs are government-backed instruments that allow you to invest in gold digitally, without the need to purchase physical gold. You can find SGBs being issued by the RBI and offered in grams of gold. They offer you a fixed 2.5% annual interest rate on the initial principal that is paid out half-yearly. In addition, you realise capital gains throughout your investment term.
It is crucial to understand that SGB rates may fluctuate based on the gold rates prevailing in the market. Before investing, note that these bonds have an 8-year maturity term. To exit your positions, you must hold your units for at least 5 years and can only exit on an interest payout date.
As far as taxation is concerned, remember these pointers:
- Your interest earnings from SGBs are taxed according to your income tax slab rate.
- Capital gains are levied as per your holding period. If you hold the bond until maturity, the capital gains are exempted from taxes. On the other hand, if you sell your possession after 5 years of holding and before 8 years of the buying date, then you have to bear an LTCG of 12.5%.
Zero-Coupon Bonds
Zero-coupon bonds do not pay you any interest but you can obtain them at discounted rates. On maturity, you receive the full face value of the bond.
The Government does not impose tax on purchasing zero coupon bonds as they do not offer any interest. However, you have to bear the capital gains tax, which will be determined by the holding period. The National Bank for Agriculture and Rural Development (NABARD), Rural Electrification Corporation (REC), etc. issue this type of bonds.
Final Word
As bonds provide dependable returns, they are a popular investment option for conservative investors. Regardless of the advantages, you should clearly understand the taxation of bonds in India to accurately estimate your final returns. Getting this part right will bring you one step closer to making a financially sound decision.
Yet, if you find any part of this guide difficult to understand, it is highly advised to consult a financial advisor before making investment decisions.
Frequently Asked Questions
If you hold your gold bond units until maturity, you are no longer liable for capital gains tax. However, if you sell your holdings before 8 years from the date of purchase but after 5 years, you are subject to a 12.5% long-term capital gains (LTCG) tax.
Under Section 193 of the Income Tax Act, 1961, TDS is applied to the interest you earn from bonds. This means that a certain percentage of your interest income will be directly deducted by the issuer and paid to the government. This TDS rate is generally 10% for both listed and unlisted bonds.
When you hold corporate bonds in your portfolio and their annual yield crosses ₹5,000, you have to bear a 10% TDS on selling them. However, if the returns come lower than ₹5,000, you can submit Form 15G to the bond issuer, requesting them not to deduct the TDS amount. For senior citizens, there is a separate form, 15H.
In India, several government-backed enterprises issue tax-free bonds at different times. Among them, some popular issuers include the Housing and Urban Development Corporation (HUDCO), National Highways Authority of India (NHAI) and Indian Railway Finance Corporation (IRFC).
