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Explained: How are bond investments taxed?

Explained: How are bond investments taxed?

Explained: How are bond investments taxed?
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By Anshul  Aug 22, 2020 5:07 PM IST (Updated)

Bonds are a type of investment that results in an investor lending money to the bond issuer in exchange for interest payments.

Bonds are type of investment that results in an investor lending money to the bond issuer in exchange for interest payments. In simpler terms, bond investments work like a formal contract where borrowed money is repaid with an interest at fixed intervals.

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There are various types of bonds available with different duration, coupon rates and lock-ins. The taxation structure is also contingent upon the type of bond.
According to Sonam Chandwani, managing partner at KS Legal & Associates, the interest earned from investments determines the tax applicable on the earnings in case of regular taxable bonds. On the other hand, interest earned from tax-free PSU bonds is exempt from taxes.
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However, any appreciation realised at the time of sale or redemption is still taxed as income from capital gains in case of tax-free bonds. Capital gain is the difference between sale price (net off brokerage and selling expenses) and purchase price (increased by brokerage and selling expenses, if any)
"Investments should not be made merely on the fact that interest is tax-free, but must be aimed at capitalising the primary rule of investing – product choice, risk appetite, and liquidity requirements that drive financial goals," suggests Chandwani.
On the sale of bonds, capital gains are taxed as short term capital gains (STCG) or long term capital gains (LTCG) depending on holding period and whether these are listed or not.
"Capital Gains are considered long-term for listed bonds, zero coupon bonds (whether quoted or not) if they are held for a period exceeding 12 months. On the other hand, in the case of unlisted bonds, capital gains are long-term if they are held for a period exceeding 36 months," explains Sandeep Sehgal, director - tax and regulatory, AKM Global, a consulting firm.
STCG from sale of bonds is taxable as per applicable slab rates.
LTCG arising from sale of bonds (listed and unlisted) are taxable under section 112 at the rate of 20 percent.
"A non-resident investor can choose to pay tax on LTCG arising from sale of unlisted bonds at the rate of 10 percent without benefit of indexation. Further, option to avail 10 percent rate is also available in case of long term listed bonds to all investors (resident and non-resident) without benefit of indexation,” Sehgal elaborates.
Benefit of indexation is not available for bonds issued by an Indian company as it is restricted to LTCG arising from the sale of capital indexed bonds issued by the government and Sovereign Gold Bonds issued by RBI under the Sovereign Gold Bond Scheme, 2015.
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