Tax on Bonds

Taxation on bonds in India involves two main components: interest income and capital gains. The interest income is taxed as per the investor’s income tax slab rate and capital gain tax is subject to the holding period and listing status of the bond. The tax on bonds also depends on the type of bond, i.e., whether the investor is holding a government bond, a tax free bond, or a capital gain bond. 

Corporate Bonds and Government Bonds

Corporate and government bonds include fixed and floating rate bonds, zero coupon bonds, puttable and callable bonds. In addition, government bonds also include Inflation Indexed Bond (IIB), Capital Indexed Bonds, Sovereign Gold Bonds (SGBs), 7.75% Savings (Taxable) Bonds, 2018. 

Before evaluating the tax implications, investors should also consider whether high yield bonds or low risk bonds align better with their financial goals and risk appetite. You can explore and invest in bonds through the Paisabazaar app and earn fixed returns of up to 13.25%.

Tax on Interest Income

The interest income received from bonds is added to the investor’s total income and is taxed according to the investor's applicable income tax slab rates. 

Capital Gains Tax

Capital Gain refers to the profit an investor makes when selling a bond in the secondary market. This profit is subject to a capital gains tax, depending on the holding period and whether the corporate bond is listed or unlisted:

In case of listed bonds, capital gain tax implications are as follows:-

In case of unlisted bonds, capital gain tax implications are as follows:-

Tax Treatment of Sovereign Gold Bonds

Capital Gain Bonds - Section 54EC Bonds

Capital Gain Bonds allow their investors to claim income tax exemption on the Long Term Capital Gains (LTCG) arising from the sale or transfer of long-term capital assets, being land, buildings, or both. Investors can invest the entire LTCG component or a portion of it (capped at Rs 50 lakh per financial year) in these Section 54EC bonds to claim the tax exemption. 

However, the maturity proceeds of capital gain bonds are not taxable. Rural Electrification Corporation Limited (REC bonds), Indian Railway Finance Corporation Limited (IRFC bonds) and Power Finance Corporation Ltd (PFC Bonds) are eligible bonds available for income tax exemption under Section 54EC of the Income Tax Act. 

Case Study

Q: Mr Madan invests Rs 80 lakh capital gain arising from the transfer of land (on 1 May 2024) in NHAI bonds redeemable after 5 years under Section 54EC. What are the tax implications?

A: Mr Madan can claim tax exemption only for Rs 50 lakh capital gains, whether such investment is made during the relevant previous year or subsequent previous years, or both. Furthermore, the exemption can be availed only if the investment in NHAI bonds is made before 1 November 2024, i.e, within 6 months from the date of transfer. 

Tax Free Bonds

Tax Free Bonds is a category of bonds that offer tax exempt interest income under Section 10 of the Income Tax Act. This helps investors in higher tax brackets retain more of their returns. However, any capital gains arising from selling tax free bonds in the secondary market are subject to capital gains tax, depending on the holding period.

Masala Bonds - Rupee-Denominated Bonds - RDBs

Masala Bonds were introduced to enable Indian companies to raise funds from outside India. The capital gains arising from masala bonds are exempt from tax. The profits arising on account of appreciation of the rupee between the date of purchase and the date of redemption of the masala bond of an Indian company held by the non-resident assessee against foreign currency in which the investment is made are not included in the calculation of the full value of consideration. This provides relief to the non-resident investor who faces the risk of currency fluctuations.  

Zero Coupon Bonds

The income from the transfer of a zero coupon bond is treated as STCG or LTCG, subject to the holding period. Further, according to Section 2(47)(iva) of the Income Tax Act, the maturity proceeds or redemption of a zero coupon bond is treated for capital gain tax. STCG (held for 12 months or less) is taxed as per the investor’s income tax slab rate. LTCG (held for more than 12 months) is taxed @ 12.5%, without indexation benefits.