Capital Gains and Interest on Bonds: Everything You Need to Know
Once you have invested in bonds, you generate two types of income – interest and capital gains. When you redeem bonds at maturity or sell them in the secondary market, the profit earned is considered a capital gain. While a bond’s interest income is taxed at an individual’s slab rate, capital gain taxation varies with the holding period.
Taxation on Capital Gains
Regarding capital gains from the sale of bonds, the tax implications depend on the holding period of the bond and whether it is listed or not. If a listed bond is held for less than 12 months, any gain from the sale is considered short-term capital gain (STCG). STCGs are taxed at the individual’s slab rate.
If held for over 12 months, the gain is considered a long-term capital gain (LTCG). LTCG is taxed at 10% without indexation or 20% with indexation, plus a surcharge.
Indexation adjusts an investment’s purchase price to reflect inflation’s effect. It is an efficient way to prevent the draining of your investment returns through taxes. You can lower your long-term capital gains through indexation, thus, bringing down your taxable income.
For unlisted bonds, if held for less than 36 months, any gain from the sale is considered STCG and is taxed at the individual’s slab rate. However, if the unlisted bond is held for more than 36 months, the gain is considered LTCG and is taxed at 10% without indexation or 20% with indexation, plus surcharge and cess.
Short-term Capital Gains (STCG):
Short-term capital gains from the sale of bonds are taxable per your income tax slab.
Example: You purchased a listed bond for Rs. 1,00,000 on 16th June 2022 and sold it on 8th February 2023 for Rs. 1,10,000. In this case, the gain you made by selling the bonds is Rs. 10,000. The tax on STCG is calculated at your individual income tax slab rate. Let’s assume that your income tax slab rate is 30%. In this case, the tax liability on the STCG of Rs. 10,000 would be Rs. 3,000 (30% of Rs. 10,000).
Long-term Capital Gains (LTCG):
Long-term capital gains from the sale of bonds are taxable under Section 112(1)(c) of the Income Tax Act. The tax rate for long-term capital gains depends on whether the gains are indexed or non-indexed. Indexation is a process that adjusts the bond’s purchase price to inflation, reducing your tax burden.
- Indexed Long-term Capital Gains: If the gains are indexed, the tax rate is 20%, with the benefit of indexation.
- Non-indexed Long-term Capital Gains: If the gains are non-indexed, the tax rate is 10% without the benefit of indexation. Non-indexed gains do not consider inflation adjustments.
Example: Suppose you purchased a listed bond for Rs. 1,00,000 on 16th July 2017 and sold it on 8th February 2023 for Rs. 1,10,000. Since the bonds are held for more than 12 months, LTCG will apply. To calculate the tax liability for LTCG considering indexation, we need to follow these steps:
Step 1: Determine the indexed cost of acquisition:
Indexed Cost of Acquisition = Cost of Acquisition x CII of the year of sale/ CII of the year of purchase
= Rs. 1,00,000 x 348 /272 = Rs. 1,27,941.18
Step 2: Calculate the Long-Term Capital Gain:
Long-Term Capital Gain = Selling Price – Indexed Cost of Acquisition
= Rs. 1,50,000 – Rs. 1,27,941.18 = Rs. 22,058.82
Step 3: Apply the LTCG tax rate:
The LTCG tax rate is 20% for long-term capital gains with indexation.
Therefore, the tax liability = LTCG x LTCG tax rate
= Rs. 22,058.82 x 0.20 = Rs. 4,411.76
The tax liability for LTCG would be Rs. 4,411.76.
Taxation on interest earned
Interest income from bonds is taxed at an individual’s slab rate and is filed under Section 56(2)(ia) of the Income Tax Act. This interest income forms part of the “Income from other Sources” income head of the return of income. It is essential to note that the tax liability on interest income depends on the individual’s income tax slab rate.
For example, if an individual falls under the 30% tax slab and earns an interest income of Rs. 10,000 from bonds, the tax liability would be Rs. 3,000.
How to claim the accrued interest on bonds?
When treating and reporting accrued interest on bonds during the transfer of ownership in India, there are different approaches to consider. One method is to include the accrued interest in the purchase price of the bonds. In this situation, the buyer compensates the seller by paying a total consideration that combines the principal amount and the accrued interest. The bond buyer pays the consolidated total value in a single payment to the seller.
Another method is when the buyer and the seller opt for separate reporting of the accrued interest component. Under this approach, the buyer pays the principal amount upfront, while the seller receives a separate payment for the accrued interest. This method allows for the distinction between the principal and accrued interest portions of the transaction, facilitating accurate accounting and reporting.
It’s important to note that the choice of treatment and reporting methods should align with the specific circumstances of the transaction and comply with the relevant provisions of the Income Tax Act, 1961, in India.
To ensure accurate tax filing and compliance, it is always recommended to seek professional guidance from a qualified tax advisor or refer to the latest guidelines issued by the Income Tax Department. By staying informed about the tax implications of bond investments, you can effectively plan your investment strategies and fulfil tax obligations.
Frequently Asked Questions (FAQs)
Do I have to pay tax on debt funds?
You pay tax on debt funds depending on their holding period. You pay taxes on short-term gains if the holding period is less than three years. The profits are added to your taxable income, and you pay tax at the applicable tax slab. When the holding period is over 36 months, you pay tax at a flat rate of 20% after indexation.
Can I offset capital losses from selling bonds against other capital gains?
Yes, you can offset capital losses from selling bonds against other capital gains within the same financial year. However, an unadjusted capital loss can be carried forward for up to eight subsequent years for set-off against future capital gains.
Are there any exemptions or deductions available for bond investment earnings?
Per the current Income Tax Act provisions, no specific exemptions or deductions are available for bond investment earnings. Interest and capital gains are taxed per the prescribed rates and rules.
Do non-resident Indians (NRIs) have different tax implications for bond investments in India?
Yes, NRIs have different tax implications for bond investments in India. The tax treatment depends on their residential status and the specific provisions of the Income Tax Act applicable to NRIs. NRIs are only allowed to invest in NRI eligible bonds and not all the bonds. They should consult a tax advisor specialising in NRI taxation to understand their tax obligations in detail.