The Fixed Income Securities are known for their security and certainty. As they are becoming popular across all sets of investors, it is important to understand their tax implications. With various securities from T-bills, to numerous types of bonds, the taxability differs for each product. Some bonds offer payouts that are tax-free, while some bonds help in tax savings, but are still taxable, whereas some bonds have their capital gain exempt but some bonds have a premium on redemption charged as interest and not capital gain.
To simplify the above ambiguity, we should look at the different cash flows we receive from various securities:
- Coupon Interest: There is a fixed payment made by bonds on the face value of the security, annually, semi-annually, quarterly, or monthly. These coupon interest pay-outs are at pre-decided rates and dates. These payments are chargeable as “Income from Other Sources”(IFOS), in the hands of the receiver. The tax rate would be as per the slab rates of the investor. Any expenses incurred, to obtain this interest (like fees or commissions) are allowed as a deduction from taxable income.
Exception: Tax-free Bonds issued by Government Enterprises like REC, IRFC, NHAI, etc. give the investor an exemption from tax on the interest payments received. However, capital gain if any, made on sale of this bond is taxable.
- Staggered Payments: Some issuers, choose to pay the principal of the bond in instalments, unlike giving a lump sum payment at the end of the duration of the bond. These inflows are not taxable in the hands of the investor. If interest and part principal is paid together, only the interest is taxed under IFOS.
- Redemption of Debenture: At maturity, when the company redeems the principal amount of the debenture, it is not taxable in the hands of the Investor, if the company is redeeming the debenture at par. If the company pays a premium, the assessee will generate a profit if his purchase price is lower than the redemption value. This profit is considered as capital gain and is charged according to the period of holding and specific rate.
Zero Coupon bonds do not pay coupons, but are sold at a discount and are redeemed at par. The difference between the maturity price and purchase price of the bond is taxed as capital gains.
Exception: Sovereign Gold Bonds issued by the RBI, are redeemed at an average market price of gold, in the week before redemption. The capital gains made by the investor, are completely exempt from tax. (However, the 2.5% coupon interest paid is chargeable under IFOS, as per the investor’s tax bracket)
- Sale Proceeds of a Bond: Bonds are sold in the secondary market. An investor will attract capital gain tax if he sells the bonds for a value higher than his buying price. The period of holding and the type of bond(listed/unlisted) will attract a particular rate of interest.
(Capital Gain Bonds, also known as 54EC bonds are called tax saving bonds. Capital gains arising on the sale of long-term capital assets being immovable property can be avoided by investing in these bonds issued by NHAI, PFC, REC, and IRFC within 6 months of the sale. Tax-saving bonds are regular bonds from a tax perspective. IFOS is attracted for interest pay-outs and Capital gains on redemption/sale)
Understanding Capital Gains Taxation in Bonds
- Period of Holding
| Type of Bond | Short Term Capital Asset | Long-Term Capital Asset |
| Listed Bonds | Less than or equal to 12 months | More than 12 months |
| Unlisted Bonds | Less than or equal to 36 months | More than 36 months |
- Rate of Tax for Bond:
| Type of Bond | Short Term Capital Gains | Long-Term Capital Gains |
| Listed Bonds | Slab Rate | 10% without Indexation (section 112) |
| Unlisted Bonds | Slab Rate | 20% without Indexation (section 112) |
TDS: Tax deducted at Source on Interest income from bonds
Under Section 193 of the applicable regulations, anyone who pays interest on securities to a resident is obligated to deduct TDS (Tax Deducted at Source). The issuer is responsible for deducting TDS at a rate of 10%. However, if the recipient fails to provide their Permanent Account Number (PAN), the deductor becomes liable to deduct TDS at a higher rate of 20%.
According to the Budget announcement effective from April 1, 2023, all companies that pay interest on securities are now required to deduct tax at a source rate of 10%. Previously, unlisted companies were already covered under Section 193, but with the recent amendment, listed companies are also included in the scope of TDS liability for interest payments. It’s important to note that this amendment applies exclusively to companies. Therefore, government bonds, including sovereign gold bonds, remain exempt from the TDS provision. For investors in the lower tax bracket, there is an option to submit Form 15G/H, similar to bank fixed deposits, to avoid tax deductions by the issuer.
Bonds help an investor grow their wealth, securely. Once an investor has the right guidance about taxation, he is empowered to make an informed decision. An investor can plan his holding period, understand the TDS implications and effectively choose the right options for his portfolio.
Conclusion
To summarize from the investor’s standpoint, the taxation of bonds holds significant importance in shaping the overall profitability and appeal of this investment option. The tax consequences, such as the implementation of tax deducted at source (TDS), directly influence the after-tax returns and the convenience associated with investing in bonds. Investors must exercise caution when assessing various bond types and their corresponding tax policies, remaining well-informed about current tax laws, exemptions, and provisions pertaining to bonds. Staying updated ensures informed decision-making when it comes to investment choices.