The bond investors check many parameters while investing in bonds, such as a coupon, frequency of coupon payments, maturity, and yield. Did we miss anything?
Yes, the equally important factor to be considered in bond investment is “Taxation on gains from bond investment.” Let’s discuss and understand- Taxation on gains from bond investments.
Before we get into further details, let’s look at a few fundamental points.
- The slab system defines the tax rate applicable to individuals considering age and income. Individuals can be resident or non-resident or HUF or Association of Person or Body of Individual or any other artificial juridical person. The applicable tax rate is called the slab rate. To know your slab rate, you can refer to the notice served by the Income Tax Department.
- TDS will not be deducted on interest received from listed bonds and debentures.
- Bonds provide coupon payments and return principal amount on maturity. Firstly the coupon payments are the gains from bond investment; hence they are taxable. Secondly, you may sell bonds in the secondary market before maturity, or you may hold bonds till maturity. In either of the cases, if there is capital gain, then the gains are taxable.
- The bonds listed on the National Stock Exchange are Listed Bonds, and bonds that are not listed on the National Stock Exchange are called Unlisted Bonds.
- Short Term Capital Gain Tax is applicable if you sell listed bonds before 12 months(it is 36 months in the case of unlisted bonds).
- Long Term Capital Gain Tax is applicable if you hold listed bonds for more than 12 months or hold unlisted bonds for more than 36 months. Refer to the table below.
Taxation on bonds can be explained in four sections.
Section 1: Regular Taxable Bonds
Section 2: Tax-Free Bonds
Section 3: Tax Saving Bonds
Section 4: Zero-Coupon Bonds
Regular Taxable Bonds
The interest earned from Bonds is taxed as per marginal slab rate, and the maximum slab rate is 30 %. Appreciation of the bond price is considered as capital gain and taxed accordingly. If these bonds are held for the long term ( more than 12 months for listed bonds and more than 36 months for unlisted bonds), the capital gain tax will be 10 %. Short-term capital gain tax can be 5% to 30%.
Mr. Ramesh is a senior citizen aged 65. He has invested Rs. 10 lakh in listed bonds. The coupon rate, i.e., interest rate, is 10% paid annually. His annual income is 9 lakh. So, he comes under the 20% slab rate.
Investment amount – 10,00,000
Coupon rate -10%
Annual Interest income – 1,00,000
Tax on interest income:
Tax – 20%X 1,00,000
Ramesh has to pay Rs. 20,000 tax on interest income every year till maturity or till he resells bonds.
After 10 months, if he sells bonds for Rs.10,50,000, then the capital appreciation is Rs.50,000
Tax- 20% X 50,000
Tax – 10,000
Ramesh has to pay Rs.10,000 as Short Term Capital Gain Tax.
After three years, if he sells bonds for Rs. 13,00,000, then the capital appreciation is Rs. 3, 00, 000.
Tax – 10% X 3,00,000
Ramesh has to pay Rs. 30,000 as Long term Capital Gain Tax.
The income should be listed under the ‘income from other sources’ section in your income tax forms. Form-16 is issued by employers every year. Here you can see a sample of Form- 16.
In the case of Tax- free bonds, the interest earned from bonds is not taxed, but price appreciation of the bonds during maturity (or sale) is considered as capital appreciation. Hence capital gain taxes are applicable. Considering the holding period, either LTCG or STCG, will be applicable.
Tax Saving Bonds
54EC Bonds are Capital Gain Tax Exemption Bonds that provide100% tax exemption on the long term capital gain earned by selling any property. These bonds are the best options to save tax after the property sale. But conditions apply, such as the time gap between property sale and bond investment can not exceed six months. Also, the investment limit in 54EC Bonds is 50 lakhs.54 EC Bonds do not provide any exemption on short term capital gains.
Zero-coupon bonds do not pay interest, but they are sold at a discount and return full face value on redemption. Investors of Zero-Coupon Bonds are subjected to capital gains tax only. Price appreciation during the sale or maturity is considered as capital gain and taxed accordingly.
- Inclusion of accrued interest should not be missed while selling the bonds in the secondary market. During the calculation of capital gain tax, the inclusion of accrued interest reduces the capital gains hence can save capital gain tax.
- Indexation benefits can be availed only in the case of inflation-indexed bonds or capital indexed bonds.
Taxation is always a complicated process. Bond investments do provide options to save tax. It is still good to seek advice from Tax Consultant before investing in bonds and debentures.