In our bond series, until now, we have discussed what bonds are, how they work, different types of bonds, important bond terms to know about, risks in bond investing, and why you should invest in bonds and diversify your portfolio.
Now, we want to focus on the next step. Typically, whenever we Indians think about investments, our main focus will be on returns and taxes. And in this post, we will focus on the returns generated from bond investments and how are they taxed.
Estimated read time: 4 minutes and 29 seconds
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Buckle up. Here we go!
What are the returns from bond investments?
When you invest in bonds, you can receive two primary types of returns.
1. Coupon/Interest income
The coupon or interest income is the regular payment you receive from the bond issuer for lending them money.
When you buy a bond, you are lending money to the issuer. In return, they promise to pay you periodic interest payments. The coupon rate is specified at the time of issuance and remains fixed throughout the life of the bond.
For example, if you have a bond with a face value of ₹10,000 and a coupon rate of 5%, you will receive ₹500 (5% of ₹10,000) as interest income each year. These interest payments are typically made semi-annually or annually, depending on the bond terms.
2. Capital gains
Capital gains refer to the profit or loss you make when selling a bond at a price higher or lower than its original purchase price.
You realize a capital gain when you sell a bond for more than you paid. Conversely, if you sell it for less than the purchase price, you incur a capital loss.
The price of a bond in the secondary market (where bonds are bought and sold after their initial issuance) can fluctuate based on changes in interest rates, credit rating of the issuer, market conditions, and other factors. As a result, the market price of a bond may differ from its face value (the amount you will receive at maturity).
For example, if you bought a bond with a face value of ₹10,000 at a discounted price of ₹9,500 and later sold it for ₹10,200, you would realize a capital gain of ₹700 (₹10,200 – ₹9,500).
It’s important to note that you do not realize capital gains or losses until you sell the bond. If you hold the bond until maturity, you will receive the face value back, regardless of any fluctuations in the market price during the holding period.
Now that we understand the two types of returns your bond investments can generate. Let’s understand the tax implications of those.
Tax on Coupon/Interest income from bond investments
In India, the tax on coupon/interest income from bond investments is classified under two major categories: Taxable Bonds and Tax-Free Bonds. Let’s explore each one in detail.
1. Taxable bonds
As the name suggests, interest income from taxable bonds is subject to tax.
The interest earned from these bonds is taxable income, and you need to include it under “Income from other sources” while filing your annual income tax return (ITR).
The tax rate applied depends on your income tax slab. This means that if you belong to the 20% tax slab, the interest earned will be taxed at 20%, and so on.
Tax Deducted at Source (TDS): According to the Budget announcement effective from April 1, 2023, under Section 193, all companies that pay interest on securities are now required to deduct tax at a source rate of 10%.
Remember, this amendment applies only to corporates. Therefore, government bonds, including sovereign gold bonds, remain exempt from the TDS provision.
2. Tax-free bonds
Tax-free bonds offer a unique benefit where the interest earned is entirely tax-free!
Government and public sector undertakings (PSUs) typically issue these bonds to raise funds for various projects of national importance. The interest income from tax-free bonds does not attract any income tax, making them an attractive option for investors seeking tax-efficient returns.
However, it’s essential to note that while the interest is tax-free, the capital appreciation (if any) upon selling these bonds is not exempt from capital gains tax.
Tax on capital gains from bond investments
Capital gains tax applies when you sell your bonds at a higher price than the purchase price. The holding period and the type of bond (listed/unlisted) will attract a particular tax rate. The tax on capital gains is classified as Short-term Capital Gains (STCG) and Long-term Capital Gains (LTCG).
1. Short-term Capital Gains (STCG)
If the bond is listed and you sell your bonds within 12 months of purchase, any profit earned is considered STCG and is taxed at your applicable income tax slab rate. This means you’ll pay taxes on the gains as per your tax bracket.
For unlisted bonds, the holding period for STCG is 36 months, and the gain is taxed at your applicable income tax slab rate.
2. Long-term Capital Gains (LTCG)
If the bond is listed and you sell your bonds after 12 months of purchase, any profit earned is considered LTCG. The LTCG tax rate for listed bonds is 10% without indexation.
For unlisted bonds, if you sell your bonds after 36 months, any profit earned is considered LTCG. The LTCG tax rate for unlisted bonds is 20% without indexation.
However, some bonds, like capital-indexed bonds and sovereign gold bonds, qualify for indexation benefits. Indexation adjusts the purchase price based on inflation, leading to a lower tax liability.
Bonds exempted from the capital gains tax
Some bonds are exempted from capital gains tax, and these can be beneficial for you.
1. 54EC bonds or capital gain bonds
Under Section 54EC of the Income Tax Act, if you invest the proceeds from the sale of an immovable long-term asset (land or building) into specific bonds issued by NHAI or REC within six months, you can claim exemption from LTCG tax.
The maximum amount eligible for exemption is ₹50 lakhs for the current and subsequent financial year.
2. Sovereign Gold Bonds (SGBs)
Although not traditional bonds, Sovereign Gold Bonds issued by the government are eligible for capital gains tax exemption upon redemption. If you hold SGBs until maturity (eight years), the gains are entirely tax-free. We have covered SGB in detail here.
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Still Curious?
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
BondsIndia – Taxation of Bonds: Investor Perspective
The Fixed Income – Taxation of Bonds in India
Quicko – Income Tax on Bonds & Debentures
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.