The interest earned on fixed-income investments like bonds and debentures is subject to income tax. There are different taxation rules for government, corporate, public sector bonds and corporate fixed deposits. While the Indian Income Tax Act, 1961 offers bondholders clear guidelines on taxation for income generated from salary, business, and assets, fixed-income investments are slightly more complicated.
Here’s a Quick Look at How Different Bonds are Taxed
A. Taxation of income generated from Bonds:
1. Tax on interest from regular taxable bonds
According to the income tax act of 1961, if you’ve invested in corporate bonds, then the interest earned from the bonds will be taxed at the slab rate that you fall under as per your overall income. The income should be listed under the ‘income from other sources’ section in your income tax forms.
The second important factor to consider while investing in taxable bonds is whether you will receive the interest payments at periodic intervals or whether the interest is payable in bulk at the time of maturity.
(Note: Bonds that pay interest payment only on maturity are called zero-coupon bonds. They are pretty much like Bank Fixed Deposits, except that they have higher interest rates) It is advised that even in the case of cumulative bonds, the interest be accounted for on an annual basis so as to avoid high liability due to receipt of large income at maturity.
2.Tax on interest from Tax-free PSU Bonds
In case of tax-free bonds, the interest earned is completely tax-free. You will only be taxed if there is any appreciation in the value of the bond at the time of sale in secondary market or during redemption. These bonds will be taxed as short-term or long-term capital gains depending on how long you’ve held the bond or whether it’s listed or unlisted.
B. Taxation on Capital Gains from Sale of Bonds in the Secondary Market:
1. Holding Period and Capital Gains
Any profit made from the sale of a capital asset are taxable as short term or long term capital gains depending on the duration the asset is held. The same applies to bonds as well. Capital gains from sale of Bonds will fall under short term taxation or long term taxation based on the tenure of holding the bond. The tenure of holding for short/ long term taxation is different for listed and unlisted bonds.
2. Listed & Unlisted Bonds
Listed bonds refer to bonds that are listed on the Stock Exchange of India. Listed bonds fall under long-term capital gains if they’re held for more than 12 months. For unlisted bonds, in order to qualify for long term capital gains, the holding period has to be more than 36 months.
Hence, listed bonds enjoy the benefits associated with long term capital assets faster than unlisted bonds.
3. Taxation structure
If you sell your bonds in the secondary market, then the earnings from the sale are taxed as per the capital gains clause in the Income Tax Act of India. The tax percentage is determined by the duration that the bonds were held. Short term capital gains are taxed as per the tax bracket applicable to your income, which can vary from 5% – 30%. Long term capital gains are taxed at a flat rate of 10% irrespective of the amount.
The table below captures the taxation on capital gains from bond sale:
As a bond investor, it would be crucial to understand how your investment will be taxed in order to get the maximum benefit from your investment.
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