A Guide to Taxation of Different Types of Bonds in India

Taxation of debt securities is one of the most important factors that you should consider while deciding to put money in bonds. There are different tax treatments for different types of debt securities. Some bonds come with tax benefits, such as deductions and exemptions. 

There are bonds in which you can invest in order to avoid taxation of long-term capital gains. All the taxation procedures are carried on as per different provisions of the Income Tax Act 1961. Let’s see in detail the tax paid on bonds.

What Are the Types of Bonds?

Here are the various types of bonds available for investment: 

  • Zero Coupon Bonds 

As the name suggests, these bonds do not come with regular coupon or interest payments like traditional bonds. However, these bonds are issued at a discount to bondholders but redeemable at par value. The difference between the issue and maturity value represents bond yields for investors. 

  • Perpetual Bonds 

These are a kind of fixed income debt security that does not come with any maturity date. In this sense, they are perpetual. The bond issuers will continue to pay interest to bondholders till they are called back. However, investors will not receive any kind of principal amount on this bond. 

  • Tax Free Bonds 

Public sector undertakings and government bodies are eligible to issue these bonds. The main feature associated with these bonds is that interest income earned from them is tax free. Consequently, there is no tax levied on such income. 

  • Tax Savings Bonds 

Governments issue these bonds, and they can help you to reduce your gross tax liabilities as per relevant provisions of the Income Tax Act 1961. Generally, these bonds come with a lock-in period of sixty months or five years. Governments can use proceeds received from these bonds to finance projects of national importance related to defence, infrastructure, etc. 

Now that you are aware of the various types of bonds functioning in the market let’s take a look at their taxation considerations. 

Also Read: Calculation of Short-Term Capital Gains Tax on Different Assets

Tax Treatment of Various Bonds 

The tax treatments of different bonds are as follows:

  • Regular Bonds 

Regular bonds comprise fixed rate bonds, floating rate bonds, convertible bonds, perpetual bonds, etc. Interest income earned from these bonds is taxable as per the applicable slab rates plus applicable surcharge and cess. Capital gains earned on redemption or sale in secondary markets will be subject to capital gains tax. 

In case of listed bonds, the holding period threshold is 12 months. If the holding period of such bonds is less than one year, all gains will be subject to short-term capital gains tax. The rate of short-term capital gains tax is as per the respective slab rates. 

On the other hand, if the holding period of such bonds is one year or more, all gains shall be taxable as per long-term capital gains tax. The rate of long-term capital gains tax is 10% without indexation. 

Now in case of unlisted bonds, the holding period threshold is 36 months. If you are holding such bonds for less than 36 months, short-term capital gains tax will be applicable on accrued gains. The taxation rate is similar to listed bonds. 

Whereas if the holding period is 36 months or more, all proceeds will be subject to taxation under long-term capital gains tax. The rate of long-term capital gains tax is 20% with indexation benefits. It is important to note that no TDS is applicable on the interest income of listed bonds. 

  • Tax Free Bonds 

As the name suggests, these bonds provide a tax free component to investors. Interest earned on these bonds is completely exempt from any kind of taxation. Only public sector undertakings can issue these bonds. 

However, capital appreciation of these bonds will be subject to taxation under the capital gains tax. Depending on the holding period, tax is divided into long-term capital gains tax and short-term capital gains tax. 

Since most of these bonds are listed, If the holding period is 12 months or more, long-term capital gains tax is applicable. However, if the holding period is less than 12 months, short-term capital gains tax will be levied. 

The STCG and LTCG tax rates are as follows: 

Holding periodTaxationTax rate 
Less than 12 months Short-term capital gains taxApplicable slab rates 
12 months or moreLong-term capital gains tax 10% without indexation benefit
  • Tax Savings Bonds 

Also known as 54EC bonds, these bonds are issued by government entities like NHAI, REC, and PFC. If you get any long-term capital gains from the sale or transfer of a capital asset and want to get an exemption on that, you can invest the proceeds in this bond subject to various terms and conditions to avail the tax benefit. 

 The interest earned on these bonds is taxable as per your applicable tax slab rate.

  • Zero Coupon Bonds

As the name suggests, these bonds do not come with any interest payment. Therefore, there is no question of taxation on coupon amounts. However, capital appreciation on these bonds is subject to capital gains tax. The difference between the issue price and maturity price represents capital appreciation. 

The capital gains taxation of zero coupon bonds is as follows: 

Holding periodTaxationTax rate 
Less than 12 months Short-term capital gains taxApplicable slab rates 
12 months or moreLong-term capital gains tax 10% without indexation benefit

Also Read: Long-Term Capital Gains Tax Exemption – List of Exemptions as per IT Act

Final Word

Taxation is the most important factor that you should consider while investing in a particular bond, apart from its interest rate, maturity period, etc. If you are looking to put your money in different bonds, you should conduct thorough market research before taking any decision. 

Frequently Asked Questions

What is the maturity period of tax free bonds?

Tax free bonds come with a maturity period of three types – 10 years, 15 years, and 20 years. Various government entities like NHAI, REC, IRFC, PFC, NTPC and Indian Railways are eligible to issue such bonds.

What is the difference between tax free and tax savings bonds?

In case of tax free bonds, interest income earned is free from any kind of taxation. On the other hand, tax savings bonds provide tax exemptions on the initial investment amount subject to fulfilment of terms and conditions.

What are the things to consider before investing in a bond?

You should consider various factors like your investment goals, risk level, liquidity and lock-in period of the bonds before taking any investment decision.

Do tax-savings bonds have a lock-in period?

Yes, tax savings bonds come with a lock-in period. The minimum lock-in period of these bonds is 5 years.

Animesh Gupta is a Chartered Accountant by profession and a NISM certified Mutual Fund Expert. He has over 4+ years of experience working in the Financial Services Industry. In his role at Wintwealth, he is part of the Credit and Risk team and evaluates the risk of the bonds available on Wintwealth's platform.

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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The article may also contain information which are the personal views/opinions of the authors. The information contained in this article is for general, educational and awareness purposes only and is not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision, whether related to investment or otherwise, taken on the basis of this article.

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