Taxation of Bonds in India: How Different Bonds Are Taxed?

The taxation of bonds in India varies based on the bond type and holding period. This makes it essential for investors to understand how their returns are affected. Different instruments, including government securities, corporate bonds, and tax-free bonds, follow distinct tax rules. Understanding the tax on bonds in India enables investors to make informed decisions and plan their portfolios more effectively.

What are Bonds?  

A bond represents a debt instrument. A company or government borrows funds from an investor through bonds. In return, the issuer pays interest at regular periods. The principal amount is reimbursed on the maturity date. Investors are lead to bonds for the stable income they offer. They also offer possibilities for capital appreciation if sold above the purchase price. Bonds are often seen as safer than equities, making them a preferred option for investors seeking regular returns while protecting their capital. However, the acceptability of bonds depends on an investor’s risk profile and financial goals. 

Types of Bonds and Their Taxation  

India offers various bond types. Each is governed by different tax regulations. Understanding these may help investors calculate their actual post-tax returns accurately. 

Government Bonds 

Government bonds are those issued by central or state governments. They are normally considered to be relatively safer investment options. Interest received from such bonds is taxed as per the applicable income tax slab of an investor. Its capital gain taxation is related to the holding period. It falls under either short-term or long-term gains. 

Corporate Bonds 

Companies issue corporate bonds to raise capital for business operations. The interest earned is added to the investor's total income. It is taxed as per their income tax slab. The tax on bonds in India depends on the duration for which the investor holds the bond before selling. Investors should understand the tax on bond interest to plan their corporate bond investments strategically. 

Tax-Saving Bonds 

Tax-saving bonds assist investors in reducing their tax liability. They typically come with a fixed lock-in period. The interest earned remains taxable according to the income tax slab. Capital gains are generally treated as long-term gains due to the mandatory lock-in structure. 

Municipal Bonds 

Municipal bonds are issued by local government bodies. They fund public development projects. In certain cases, the interest earned may qualify for tax exemption. Capital gains remain taxable depending on the holding period and the taxation of bonds in India framework.

Non-Convertible Debentures (NCDs) 

NCDs are corporate-issued instruments. They generally offer fixed interest payments to investors. The interest income is taxed according to the investor's applicable tax slab. Capital gains taxation depends on the holding period. It qualifies as either short-term or long-term.

Taxation of Interest Income on Bonds  

Interest earned from bonds forms part of an investor's regular income. It is added to the total taxable income for the financial year. It is taxed according to the individual's income tax slab. This means the tax rate varies based on the investor's income level. Tax-free bonds constitute an exception. The interest received remains exempt from taxation. Understanding the tax on bond interest helps investors avoid errors whilst filing their returns. Interest from bonds is typically reported under "Income from Other Sources" in the Income Tax Return (ITR).

Below is a structured overview of how interest is taxed across different bond categories: 

TDS on Bonds  

TDS (Tax Deducted at Source) represents the tax collected on interest earned from bonds. The issuer deducts this amount before disbursing the interest to the investor. This means investors receive their interest payment after tax has been deducted. 

Essential points regarding TDS on bonds include: 

• TDS on bond interest is deducted under Section 193 of the Income Tax Act, 1961 
• The standard TDS rate stands at 10% on interest from both listed and unlisted bonds 
• Tax-free bonds typically do not attract TDS since their interest income remains exempt 
• Zero-coupon bonds do not incur TDS as they do not generate interest payments 

Bond Taxation for NRIs  

The tax on bonds in India for NRIs is different from that for resident investors. In the case of NRIs, the tax is directly deducted from the interest earned before making the payment. Basically, interest from bonds held in an NRO account is subject to 30% TDS along with applicable charge. If the investment is carried through an NRE account, certain bonds may offer tax-free interest, depending upon eligibility and RBI regulations. Capital gains on bonds are also subject to TDS for NRIs, based on whether the gains qualify as short-term or long-term. 

Repatriation Rules 

Funds invested through an NRE account are typically fully repatriable. This includes interest and maturity proceeds. Investments through an NRO account could be repatriated up to USD 1 million per financial year. This is subject to required documentation and tax clearance. 

Special Taxation Cases 

NRIs residing in countries with a Double Taxation Avoidance Agreement (DTAA) may qualify for a reduced TDS rate. This generally ranges between 10%–15%, based on the treaty provisions. To apply for this benefit, they must provide a Tax Residency Certificate (TRC). Other requisite forms must also be submitted to the bond issuer. 

Tax-Saving Bonds & Their Benefits  

Tax-saving bonds are government-issued instruments. They are designed to help investors lower their tax liability. The interest rate is regulated by the Government of India. These bonds come with a minimum lock-in term of 5 years. The interest earned on these bonds stays taxable according to the investor's income tax bracket. Because of the required lock-in period, capital gains are regarded as long-term gains. Investors may also claim a tax deduction of up to ₹20,000 under Section 80CCF. 

Tax-saving bonds offer several advantages for strategic investors: 

• They help investors reduce tax liability whilst providing a stable investment avenue 
• Capital gains arising from the sale of long-term assets can be exempted under Section 54EC if invested in these bonds 
• To claim the 54EC benefit, capital gains must be invested within 6 months of selling the asset 
• The maximum investment for 54EC tax exemption is ₹50 lakh per financial year 
• Suitable for investors seeking long-term wealth creation and tax planning strategies 

Conclusion 

Understanding the taxation of bonds in India enables investors to plan their income and capital gains more effectively. Different instruments follow specific tax regulations on interest and gains. NRIs face additional considerations such as TDS rates and repatriation rules. Tax-saving bonds may provide long-term benefits through deductions and exemptions. Staying informed about these regulations can complement other investment decisions and enhance overall portfolio management while using a reliable Stock market trading app.