Investing in bonds can offer stable returns and portfolio diversification. However, understanding their tax implications is crucial for maximizing your net gains. In India, bond taxation primarily falls under two categories: Interest Income and Capital Gains. The tax rules differ based on the bond’s type, listing status, and your holding period.
Let’s break down the taxation of bonds in India for retail investors.
1. Taxation of Interest Income
The regular interest payments you receive from bonds, also known as coupon payments, are generally taxable.
- Taxability: Interest income from most bonds is taxed under the head “Income from Other Sources.” This income is added to your total income for the financial year. It is then taxed at your applicable income tax slab rate. This applies to:
- Government Securities (G-Secs)
- State Development Loans (SDLs)
- Corporate Bonds
- PSU Bonds (unless specifically issued as tax-free)
- RBI Floating Rate Savings Bonds
- Tax Deducted at Source (TDS):
- For listed corporate bonds and PSU bonds, a 10% TDS (Tax Deducted at Source) applies if the annual interest income from a single issuer exceeds ₹5,000. This rule came into effect from April 1, 2023 (Budget 2023).
- For Government Securities (G-Secs) and State Development Loans (SDLs), no TDS is generally deducted on interest payments to resident individuals. However, the interest remains taxable in your hands.
- If you are below the taxable income threshold, you can claim a refund of the TDS deducted by filing your Income Tax Return (ITR).
- Tax-Free Bonds (Section 10(15)):
- These are a special category of bonds. Government-backed entities typically issue them for infrastructure projects.
- The interest earned on these bonds is completely exempt from income tax under Section 10(15) of the Income Tax Act.
- No TDS is deducted on the interest from these bonds.
- Examples: Older issues from NHAI, REC, PFC, IRFC, HUDCO were popular tax-free bonds. While new issues of truly tax-free bonds are rare now, existing ones trade in the secondary market.
2. Taxation of Capital Gains
Capital gains arise when you sell a bond in the secondary market at a price higher than your purchase price. Capital gains are classified as either Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG), depending on the holding period. The tax treatment varies significantly for listed vs. unlisted bonds.
A. Listed Bonds: (e.g., most Corporate Bonds, PSU Bonds, G-Secs, SDLs traded on exchanges)
- Holding Period:
- Short-Term Capital Gain (STCG): If you sell the bond within 12 months from the date of purchase.
- Long-Term Capital Gain (LTCG): If you sell the bond after holding it for more than 12 months.
B. Unlisted Bonds: (e.g., some privately placed bonds or unlisted debentures)
- Holding Period:
- Short-Term Capital Gain (STCG): If you sell the bond within 36 months (3 years) from the date of purchase.
- Long-Term Capital Gain (LTCG): If you sell the bond after holding it for more than 36 months.
- Indexation: This is a crucial benefit for unlisted bonds held for the long term. It adjusts the original cost of acquisition for inflation using the Cost Inflation Index (CII) notified by the government. This reduces your taxable capital gains, thereby lowering your tax liability.
C. Specific Bond Categories & Their Capital Gains Treatment:
- Sovereign Gold Bonds (SGBs):
- Interest Income: Taxable as per your income tax slab.
- Capital Gains on Redemption (at maturity after 8 years): Completely exempt from tax. This is a major advantage of SGBs over physical gold.
- Capital Gains on Sale in Secondary Market (before maturity):
- If sold within 3 years: STCG, taxed at your slab rate.
- If sold after 3 years but before 8 years: LTCG, taxed at 20% with indexation benefit.
- Tax-Free Bonds (Section 10(15)):
- While interest is tax-exempt, capital gains from selling these bonds in the secondary market are taxable.
- STCG (if held ≤ 12 months): Taxed at your applicable slab rate.
- LTCG (if held > 12 months): Taxed at 10% without indexation benefit.
- Capital Gains Exemption Bonds (Section 54EC Bonds):
- These bonds (e.g., issued by REC, NHAI, PFC, IRFC) are not “tax-free” in the traditional sense.
- You can invest capital gains from the sale of long-term assets (like property) into these bonds to claim exemption from capital gains tax under Section 54EC.
- They have a lock-in period (currently 5 years).
- Interest income from these bonds is fully taxable at your slab rate.
- These bonds are non-transferable before their lock-in, so capital gains on their sale usually do not arise.
Tax in Tables: Quick Reference
Here’s a summary of bond taxation in India:
1. Interest Income Taxation
| Bond Type | Interest Income Taxability | TDS Applicable |
| G-Secs, SDLs | Taxable as per your income tax slab | No TDS for resident individuals. |
| Corporate Bonds (Listed) | Taxable as per your income tax slab | 10% TDS if interest > ₹5,000 from single issuer (effective April 1, 2023). |
| Corporate Bonds (Unlisted) | Taxable as per your income tax slab | Yes, as per applicable rules under Section 194A. |
| PSU Bonds | Taxable as per your income tax slab (unless tax-free issue) | 10% TDS if interest > ₹5,000 from single issuer (effective April 1, 2023 for listed). Rules may vary for unlisted/older issues. |
| Tax-Free Bonds (Sec 10(15)) | Completely Exempt from Tax | No TDS. |
| Sovereign Gold Bonds (SGBs) | Taxable as per your income tax slab | No TDS. |
| 54EC Bonds | Taxable as per your income tax slab | Yes, if issuer deducts TDS. |
2. Capital Gains Taxation on Sale of Bonds
| Category | Holding Period | Tax Rate (STCG) | Tax Rate (LTCG) | Key Notes |
| Listed Bonds | Short-Term: ≤ 12 months | Your Income Tax Slab Rate | 10% (without indexation) | Most G-Secs, SDLs, Corporate, PSU bonds fall here if traded on exchanges. |
| Long-Term: > 12 months | ||||
| Unlisted Bonds | Short-Term: ≤ 36 months | Your Income Tax Slab Rate | 20% (with indexation benefit) | |
| Long-Term: > 36 months | ||||
| Sovereign Gold Bonds (SGBs) | Short-Term: ≤ 3 years (on secondary market sale) | Your Income Tax Slab Rate | 20% (with indexation) | Tax-exempt if redeemed at maturity (after 8 years). |
| Long-Term: > 3 years but ≤ 8 years (on secondary market sale) | ||||
| Tax-Free Bonds | Short-Term: ≤ 12 months (on secondary market sale) | Your Income Tax Slab Rate | 10% (without indexation) | Interest is tax-exempt, but capital gains on sale are taxable. |
| Long-Term: > 12 months (on secondary market sale) |
Taxation of Bonds in India: Key Takeaways for Investors
- Most bond interest is taxable at your income slab rate.
- Tax-Free Bonds offer completely exempt interest.
- Capital gains vary based on holding period (short-term vs. long-term) and bond type (listed vs. unlisted).
- Sovereign Gold Bonds (SGBs) provide tax-free capital gains at maturity.
- TDS might apply to some bond interest, but you must still report it in your ITR.
