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.
Read More about The Taxation for Traders
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 attract tax as below:
- Interest: The interest income on bonds is taxed as per your income tax slab by adding it to your total income.
- Capital gains: The capital gains on the bonds are taxed depending on the type of the bond:
- Unlisted bonds: Gains on bonds held for more than 3 years are considered Long-Term Capital Gains (LTCG). These are taxed at 20% without an indexation benefit. The gains from bonds held for less than 3 years are considered Short-Term Capital Gains (STCG) and are taxed as per your income tax slab.
- Listed bonds: Listed bonds held for more than 1 year attract LTCG tax on gains earned thereon and are taxed at 10% without an indexation benefit. The gains from bonds held for less than 1 year are STCG, which are taxed as per your income tax slab.
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 |
|
| 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. |
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.
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FAQs
Are tax-free bonds entirely tax-free?
No, tax-free bonds do not have tax on interest income, but the capital gains from selling them can still be subject to tax based on the holding period.
Is there any maximum investment that can be made in government bonds?
The minimum investment in bonds is ₹1,000 and there is no maximum investment limit. However, consider your investment objective and invest accordingly.
What happens if I exit an SGB after 6 years?
If you exit an SGB after 5 years but before the full 8-year maturity, the long-term capital gains (LTCG) from the sale may be taxed at a 20% rate with an indexation benefit.
What is the capital gain tax on tax-free bonds?
The capital gains on the tax-free bonds are taxed as per the holding period. The LTCG is taxed at 10% without indexation benefit. STCG is taxed as per the income tax slab.
