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Capital Gains Taxation on Bonds & Debentures

August 19, 2020

It is very important for an investor to look at Post-Tax Returns when screening the universe of investment opportunities. Let us help you understand the taxation impact of various investments made in the world of Bonds & Debentures.

 

A. Taxation of interest income from Bonds:

1. Tax on interest received from taxable bonds

According to the income tax act of 1961, the interest earned from bonds will be taxed at the slab rate that you fall under as per your overall income. The income should be listed under the ‘Income from Other Sources’ section in your income tax computation.

Another factor to consider while investing in taxable bonds is whether you will receive the interest payments at periodic intervals or whether the interest is payable in bulk at the time of maturity.

In the case of cumulative bonds, the interest is to be accounted for on an annual basis. This also helps in avoiding high tax liability due to receipt of large income at maturity.

(Note: Bonds that pay interest payment only on maturity are called zero-coupon bonds)

2.Tax on interest from Tax-Free Bonds

The interest earned is completely tax-free, in case of tax-free bonds.

B. Taxation on Capital Gains from Sale of Bonds in the Secondary Market:

TYPE OF SECURITYHOLDING PERIOD TO QUALIFY AS A LONG-TERM ASSETTAXABILITY OF SHORT-TERM CAPITAL GAINSTAXABILITY OF LONG-TERM CAPITAL GAINS
Listed debentures and bonds *More than 12 monthsGains shall be taxed as per normal slab ratesGains shall be taxed @ 10% without indexation
Unlisted debentures and bonds *More than 36 monthsGains shall be taxed as per normal slab ratesGains shall be taxed @ 20% without indexation
Units of debt oriented mutual fundsMore than 36 monthsGains shall be taxed as per normal slab ratesGains shall be taxed @20% after giving effect of indexation

* except capital indexed bonds issued by the Government & Sovereign Gold Bond issued by the Reserve bank of India under the Sovereign Gold Bond Scheme, 2015

The relevant provisions in this regard are as follows:

1. Section 2(42A)

  • If a listed security is held for more than 12 months, it will be considered as a 'Long term capital asset'. This means if it is held for 12 months or less it'll be termed as 'Short term capital asset'.
  • If unlisted debentures or bonds and units of debt oriented mutual funds are held for more than 36 months, they'll be considered as 'Long term capital assets'. This means if they're held for 36 months or less, they'll be termed as 'Short term capital assets'.

Note: Period of holding refers to the time span for which an asset is held by a person, immediately prior to its transfer. It shall be computed from the date on which the asset was acquired until the date of its transfer.

2. Third Proviso to Section 48

This proviso states that indexation shall not apply to the long-term capital gain arising from the transfer of bonds or debentures.

However, it shall apply to -

  1. Capital indexed bonds issued by the Government
  2. Sovereign Gold Bond issued by the Reserve bank of India under the Sovereign Gold Bond Scheme, 2015

Note: Indexation is not applicable to any short-term capital gains.

3. Section 112

The tax payable on long-term gains (LTCG) arising from transfer of:

a. Listed debentures and bonds (except 2a and 2b) shall be lower of-

  1. 20% of LTCG without giving effect of indexation
  2. 10% of LTCG without giving effect of indexation

Thus, the LTCG in this case shall always be taxed at 10% without indexation.

b. Unlisted debentures and bonds (except 2a and 2b) shall be-

20% of LTCG without giving effect of indexation

c. Units of debt oriented mutual funds shall be-

20% of LTCG after giving effect of indexation

4. Section 111A

Short-term gains (STCG) arising from transfer of all of these shall be taxable at the normal slab rates applicable to the person.

Taxation of capital indexed bonds issued by the government and sovereign gold bonds issued by RBI

1. The tax payable on long-term gains (LTCG) arising from transfer of these being:

A. Listed bonds shall be lower of-

  1. 20% of LTCG after giving effect of indexation
  2. 10% of LTCG without giving effect of indexation

B. Unlisted bonds shall be-

  1. 20% of LTCG after giving effect of indexation

2. Short-term gains (STCG) arising from transfer of all of these shall be taxable at the normal slab rates applicable to the person.


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