Investors consider many factors such as coupon payments, lock-in period, etc., while allocating their money to bonds. But, the most important thing to take into account while investing in these financial securities is taxation.
In India, different bonds have distinct tax rules. Let’s explore them in detail.
Investors earn income through bonds in two ways: interest and capital gains.
Here are taxation systems for various bonds in India:
As the name suggests, these bonds are taxable. There are two ways of earning from these bonds — capital gains and interest. Capital gains are profits earned by an investor at the time of maturity. The net difference between the sale price and purchase price of bonds is known as capital gains.
Individuals earn interest from bonds, which is added to individuals’ gross total income and taxed according to the slab rate. For example, let’s say Mr Joshi has invested Rs. 10,00,000 in a taxable bond @10% p.a. His interest income is Rs. 1,00,000, which is added to his GTI and taxed accordingly.
Capital gains on these bonds are of two categories — long term capital gains and short term capital gains. In the case of listed bonds, if the holding period is more than 12 months, the realised returns are termed LTCG. When the holding period is below 12 months, individuals earn short term capital gains upon the sale of these bonds. STCG is taxed at applicable slab rates, while LTCG is taxed at a rate of 10% without indexation.
In the case of unlisted bonds, if the holding period is more than 36 months, gains from these financial instruments come under LTCG. The rate of taxation is 20% without indexation. However, if the holding period is less than 36 months, any gains coming from these are categorised as STCG and taxed as per the applicable tax slab rate.
Governments and PSUs issue these bonds to raise funds for various projects of national importance. The government raises money through tax-free bonds to fund infrastructure and social welfare projects like highways, railways, ports, urban and rural development, etc.
Investors do not pay any tax on interest earned from these. However, returns earned from such bonds upon maturity or sale is categorised under LTCG and STCG depending on the holding period.
Individuals with any long-term capital asset like land or building can save taxes by investing in these bonds. They can invest the sale proceeds of these assets in 54EC bonds. These bonds offer 100% LTCG tax exemption. However, this tax benefit will only be applicable if the time between sale and investment is within 6 months. Investors can earn capital gains from these. Taxation on capital gains comes under LTCG or STCG.
The government also allows deductions of up to Rs. 20,000 on investment per year. It is over and above Rs. 1.5 lakhs deduction u/s 80C.
NHAI, REC, PFC can issue 54EC bonds.
A coupon is an interest that investors earn when they invest their money in a bond. Zero coupon bonds are those that do not pay any interest but are issued at a huge discount. The investor will receive full face value on maturity.
For example, let’s say Mrs Jain invested in a zero coupon bond with a face value of Rs. 25,000. The issue price was Rs. 10,000, representing a discount of Rs. 15,000. Upon maturity, she will receive the full Rs. 25,000.
There is no regular interest payment, so there is no tax on interest. Investors can earn capital gains from these; taxation on capital gains comes under LTCG or STCG. Only NABARD, REC, and some government bodies can issue these bonds.
Bonds are less risky investment instruments that have the ability to offer stable and regular returns. Investors must thoroughly analyse taxation on various bonds and changes in tax rules before taking a plunge.