A bond is a debt instrument through which the issuer company borrows money from the lender or bondholder and, in return, is obliged to pay interest on the principal amount. The interest is called the coupon. Mostly the governments or public limited companies issue them to raise money from the public.
"When bonds are sold, investors typically earn income through interest and capital gains. Interest is taxed as 'Income from Other Sources,' whereas bond sales are taxed as 'Income from Capital Gains.' The interest is taxed at different slab rates, while short-term capital gains are taxed at a slab rate, and long-term capital gains are taxed at 20 per cent, depending on the holding period," says Suneel Dasari, founder and CEO of EZTax.in, an online income tax filing portal.
Investors consider many factors, such as coupon payments, lock-in periods, etc., while allocating their money to bonds. However, taxation is the most important aspect while investing in these financial securities.
In India, different bonds have distinct tax rules. Let's explore them in detail.
Types Of Bonds
There are two main ways by which investors earn income through bonds: interest and capital gains. The taxation systems for various bonds in India are here as follows:
A. Regular taxable bonds
1. These are taxable bonds. You could earn from these bonds in two main ways: capital gains and interest. Capital gains are the net profit an investor makes by selling a capital asset at maturity. Capital gains are the net difference between the sale price and purchase price of bonds.
2. "Individuals earn interest from bonds, added to individuals' gross total income and taxed according to the slab rate. For example, Mr Joshi has invested Rs 10,00,000 in a taxable bond @10 per cent per annum, and his interest income is Rs 1,00,000, added to his gross total income (GTI) and taxed accordingly," explains Ruchika Bhagat, chartered accountant, and MD of Neeraj Bhagat & Co, a chartered accountancy firm.
3. "In the case of unlisted bonds, if the holding period is more than 36 months, gains from these financial instruments come under the purview of long-term capital gains. The rate of taxation is 20 per cent without indexation. However, if the holding period is less than 36 months, any gains from these are categorised as STCG and taxed as per the applicable tax slab rate," adds Bhagat.
B. Tax-Free Bonds
1. These bonds are issued by governments and public sector undertakings (PSUs) to raise funds for various projects of national importance. The government raises money through tax-free bonds to fund infrastructure and social welfare projects such as highways, railways, ports, urban and rural development, etc.
2. No tax is paid on any interest earned from these bonds by the investors. However, returns from such bonds, upon maturity or sale, are categorised under long-term capital gains (LTCG) and short-term capital gains (STCG), depending on the holding period.
C. Tax-Saving Bonds: Individuals with any long-term capital asset like land or building can save taxes by investing in these bonds. They can invest the sale proceeds of these assets in 54EC bonds. These bonds offer 100 per cent LTCG tax exemption. However, this tax benefit will only be applicable if the time between the sale and investment is within six months. In addition, investors can earn capital gains from them. Taxation on capital gains comes under LTCG or STCG.
D. Zero Coupon Bonds: A coupon is the interest investors earn when investing their money in a bond. Zero coupon bonds do not pay interest but are issued at a huge discount; investors receive full face value at maturity.
"For example, let's say Mrs Jain invested in a zero coupon bond with a face value of Rs. 25,000. The issue price was Rs 10,000, representing a discount of Rs. 15,000. Upon maturity, she will receive the full Rs 25,000. There is no regular interest payment, so there is no tax on interest. Investors can earn capital gains from these; taxation on capital gains comes under long-term capital gains (LTCG) or short-term capital gains (STCG). Only NABARD, REC, and some government bodies issue these kinds of bonds," adds Bhagat.
E. Sovereign Gold Bonds: Sovereign Gold Bonds (SGBs) are government-backed security that enables investors to invest in gold without owning physical gold. These bonds are issued by the Reserve Bank of India (RBI) on behalf of the government of India and are denominated in grams of gold.
Investors looking for gold exposure and wanting to earn a fixed interest rate with the potential for capital appreciation may consider investing in SGBs. However, investors should also be aware of the risks, such as changes in the market price of gold and fluctuations in the exchange rate, before investing in any financial instrument.
Taxation Of Bonds
In India, the taxation of bonds depends on the type of bond and the holding period of the bond. The taxation rules for bonds in India are as follows:
Interest income: The interest earned on bonds is taxable as per the income tax slab rate of the individual. The interest income is added to the individual's total income and is taxed accordingly.
Capital Gains: If the bond is held for over three years, it is considered a long-term capital asset. LTCG from the sale of bonds is taxed at a flat rate of 20 per cent after the indexation benefit.
Indexation benefit is the adjustment of the bond's purchase price for inflation during the holding period, which reduces the taxable capital gain. If the bond is sold within three years of purchase, it is considered a short-term capital asset, and the gains are taxed as per the individual's income tax slab rate.
Tax-Free Bonds: Certain bonds issued by the government and public sector companies are tax-free. The interest income from such bonds is exempt from income tax. However, the capital gains from the sale of tax-free bonds are still taxable.
TDS: Tax Deducted at Source (TDS) is applicable to the interest income from bonds. The rate of TDS is 10 per cent for individuals, and 20 per cent for non-individuals, unless the individual provides a valid form 15G/15H to the bond issuer, stating that their income is below the taxable limit.
Things To Keep In Mind For The Bond Transaction From A Tax Perspective:
If you are considering investing in bonds, there are several things to remember from a tax perspective. Here are a few key points to consider:
1. Understand The Tax Implications: Before investing in bonds, it is essential to understand the tax implications of the investment. As mentioned earlier, the interest income from bonds is taxable as per the individual's income tax slab rate. Capital gains from the sale of bonds are taxed differently depending on the holding period.
2. Plan Your Holding Period: The tax on capital gains from the sale of bonds is lower for long-term investments. Therefore, it is advisable to plan your holding period to maximise tax benefits.
3. Keep Track Of TDS: If you earn interest income from bonds, you should keep track of the TDS deducted from the income. You can claim credit for the TDS while filing your income tax return.
4. Invest In Tax-Free Bonds: Certain bonds issued by the government and public sector companies are tax-free. Therefore, investing in tax-free bonds can help you earn tax-free interest income.
5. Claim Deductions: You can claim deductions on the interest paid on loans to invest in bonds. However, the maximum deduction is limited to the interest earned on the bonds.
6. Consult A Tax Expert: The taxation rules for bonds in India can be complex, and it is advisable to consult a tax expert to understand the tax implications of your investment.
Considering these points, you can make informed decisions about investing in bonds and minimise your tax liability.
