Capital Gains vs Interest Income: What’s More Tax-Friendly?

In India, the taxation of bonds is governed by the Income Tax Act, 1961, and has two separate parts:

• First, the interest you receive from a bond

and

• Second, the capital gains

If we talk about the first part, that is interest income, it is taxed according to your income tax slab. Whereas the taxation of capital gains depends on how long you held the bond and whether it is listed or unlisted. 

Okay, but which option is more tax-friendly? Read this article to first check out the latest taxation rules (as per the Union budget 2025) and then see which type of income leads to a lower tax liability.

What is Capital Gains Tax on Bonds?

Capital gain is the profit you make when you sell a bond for a higher price than what you paid. This profit is taxable as per the provisions of the Income Tax Act, 1961. The tax you pay depends on two factors:

1. Whether the bond is listed or unlisted

and

1. How long you held the bond before selling (holding period)

Let’s understand in detail:

1. Listed Bonds

Listed bonds are traded on recognised stock exchanges. After the latest amendments introduced under the Union Budget 2025, the capital gains arising from their transfer as taxed as follows:

*This rate applies to bonds transferred on or after July 23, 2024.

2. Unlisted Bonds

Unlisted bonds are not traded on stock exchanges and are usually traded via private placements. Let’s see how profits earned from them are taxed:

*This rate applies to bonds transferred on or after July 23, 2024.

How is Interest Income from Bonds Taxed?

Interest income from bonds is treated as “regular income” under the Income Tax Act. It is not given any special tax rate. The tax you pay depends on your income tax slab. Let’s see how:

• When you receive interest from a bond, the amount is added to your total annual income under the head “Income from Other Sources”. 
• You are supposed to report this income along with your other sources, such as salary, business income, dividends, etc. 
• Now, the final tax is calculated based on the slab rate applicable to you (for example, 5%, 20%, or 30%, plus applicable cess).

Additionally, as per Section 193, bond issuers must deduct TDS (Tax Deducted at Source) @ 10% from the interest income (applies to both listed and unlisted bonds). This TDS can be adjusted against your final tax liability at the time of filing an Income Tax Return (ITR).

Which Income Type is More Tax-Friendly?

As mentioned before, interest income and capital gains are two different sources of income, and each follows separate tax rules.

• Interest income from bonds and STCG is added to your gross total income and taxed according to your income tax slab.

but

• LTCG is treated differently. Instead of slab rates, LTCG on bonds is taxed at a flat 12.5%, without any indexation benefit.

Now, the tax friendliness of these options depends on the income tax slab applicable to you. Firstly, let’s check out the latest slab rates under the new tax regime for FY 2025–26 (AY 2026–27):

Since you are aware of the slab rates, now let’s see which income type is more tax-friendly and when:

Case 1: Total Income Exceeds ₹12 Lakh

When your total income is above ₹12 lakh under the new tax regime, you move into a 15% or higher tax slab. In this situation, interest income from bonds and STCG is:

• Added to your gross total income 

and

• Taxed at your applicable slab rate

This means they are taxed at 15%, 20%, 25%, or 30% (progressively), depending on your income level. In this case, the LTCG may result in a lower tax outgo due to a lower rate of 12.5%. Therefore, for investors in higher income brackets, LTCG could be more tax-friendly than interest income or STCG.

Case 2: Total Income is ₹12 Lakh or Below

When your total income is ₹12 lakh or less under the new tax regime, you are eligible for the Section 87A rebate (available up to ₹60,000), which effectively reduces your total tax liability to zero. As a result, interest income and STCG, even though taxed at slab rates, do not lead to any actual tax payment.

However, LTCG on bonds does not qualify for this Section 87A rebate. LTCG continues to be taxed at 12.5% (regardless of your income level). As a result, in this income range, 

• Paying 12.5% tax on LTCG is 

higher than 

• Paying zero tax on interest income or STCG

Hence, interest income and STCG may be more tax-friendly than LTCG for investors with total income up to ₹12 lakh.

To Conclude, The Tax Friendliness of Capital Gains or Interest Income Depends On Your Income Level

So now you know how STCG, LTCG, and interest income from bonds are taxed, and which income type can be more tax-friendly. If we talk about which option leads to a lower tax liability, it is important to understand that the answer depends on your total income level.

For investors earning more than ₹12 lakh, interest income and STCG are taxed at higher slab rates of 15%, 20%, 25%, or 30%. In comparison, LTCG on bonds is taxed at a flat rate of 12.5%. As a result, LTCG could be more tax-friendly for higher-income investors.

In contrast, for investors earning ₹12 lakh or less, the Section 87A rebate applies, which reduces the tax liability to zero. In this case, interest income and STCG attract no tax, while LTCG continues to be taxed at 12.5%. Therefore, for lower-income investors, interest income and STCG could be more tax-friendly than LTCG.

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FAQs

1. Is LTCG payable even when my income is less than ₹12 lakh?

Yes, LTCG on bonds is taxed at a flat rate of 12.5%. It does not qualify for the Section 87A rebate.

2. How are zero-coupon bonds taxed?

Zero-coupon bonds do not pay periodic interest. The difference between purchase price and maturity value is taxed as STCG (held for less than 12 months) or LTCG (held for 12 months or more) at the time of sale or maturity. While STCG is taxed at your applicable slab rate, the LTCG is taxed at a flat rate of 12.5%. 

3. Is indexation benefit still available on bonds?

No, indexation benefit is not available for bond transfers made on or after July 23, 2024.

4. When could LTCG be more tax-friendly?

LTCG could be more tax-friendly when your total income exceeds ₹12 lakh, because it is taxed at a flat 12.5%. This rate is lower than the higher slab rates (15%, 20%, 25%, 30%) applicable when your income exceeds ₹12 lakhs.

5. When could STCG be more tax-friendly?

STCG can be more tax-friendly when your total income is ₹12 lakh or below. That’s because, due to the Section 87A rebate (up to ₹60,000), the final tax liability could be reduced to zero.

Disclaimer:

This information is for general information purposes only. GoldenPi makes no guarantee on the accuracy of the data provided here; the information displayed is subject to change and is provided on an as-is basis. Nothing contained herein is intended to or shall be deemed to be investment advice, implied or otherwise. Investments in the securities market are subject to market risks. Read all the offer-related documents carefully before investing.

Bonds or non-convertible debentures (NCDs) are regulated by the Securities and Exchange Board of India and other government authorities. GoldenPi Securities Private Limited is a registered debt broker and acts as a distributor and not as a manufacturer of the product.