Comprehensive Guide to Taxation on Bonds in India

Introduction

Taxation plays a central role in how investors evaluate fixed-income instruments. While bonds offer predictable cash-flow structures, the tax treatment of interest income and capital gains can vary depending on the bond type, holding period, and applicable tax laws.

This guide explains how bond taxation works in India across government securities, corporate bonds, municipal bonds, and securitised instruments—based entirely on published frameworks.

Why Bond Taxation Matters

Understanding taxation helps investors interpret:

• actual post-tax cash flows

• differences between interest taxes and capital gains

• the effect of holding periods

• which instruments have specific tax treatments

Taxation does not determine suitability but supports clearer comparison of bond characteristics.

Tax Components Applicable to Bonds

Bond taxation in India can involve three main components:

1. Interest Income Taxation

Interest is typically taxed as per the individual's income-tax slab rate unless otherwise specified.

2. Capital Gains Taxation

Profit or loss arising from the sale of a bond.

3. TDS (Tax Deducted at Source)

Certain bonds may attract TDS on interest payments.

Different bond categories follow different rules under the Income Tax Act.

How Interest Income Is Taxed

Most bonds distribute interest income, which is taxable in the year of receipt.

Interest taxation key points:

• Interest from corporate bonds is typically taxable at slab rates.

• Interest from government securities is taxable but no TDS is deducted.

• Interest from certain notified municipal bonds may receive specific exemptions (if explicitly notified).

• Perpetual, SDL, and PSU bonds follow their respective interest taxation rules.

• Investors should refer to offer documents and government notifications to confirm tax applicability.

TDS Rules for Bonds

1. Corporate Bonds

TDS is applicable on interest if it crosses the prescribed threshold.

2. Government Securities

No TDS is deducted on interest paid on G-Secs.

3. Municipal Bonds

If notified as “tax-free,” they may have exempt interest; otherwise, relevant TDS rules apply.

4. Market-Linked Debentures

TDS applies as per the classification under current tax rules.

TDS does not determine total tax liability—it is merely advance tax deducted at source.

Short-Term vs Long-Term Capital Gains

Capital gains taxation depends on:

• whether the bond is listed or unlisted, and

• the holding period

Listed Bonds

• Short-Term Capital Gain (STCG): Held < 12 months

• Long-Term Capital Gain (LTCG): Held ≥ 12 months

Unlisted Bonds

• STCG: Held < 36 months

• LTCG: Held ≥ 36 months

Each category has different tax treatment.

Capital Gains Tax on Listed Bonds

Listed bonds that qualify for LTCG receive specific tax treatment:

Short-Term Capital Gains (STCG)

Taxed as per the investor’s income-tax slab rate.

Long-Term Capital Gains (LTCG)

Taxed as per the prevailing rules for listed securities without indexation benefits.

Taxation may evolve with Finance Act updates, so investors should refer to current rules.

Capital Gains Tax on Unlisted Bonds

• STCG on Unlisted Bonds

Taxed at slab rate.

• LTCG on Unlisted Bonds

Taxed based on current tax code and without indexation for debt instruments unless otherwise specified.

Unlisted instruments typically involve differing calculation mechanisms due to different holding period definitions.

Tax Treatment Across Bond Categories

Different bond types have unique tax considerations:

1. Government Securities

• No TDS

• Interest taxable

• Capital gains taxed based on listed-bond rules

2. PSU & Quasi-Sovereign Bonds

Taxed like corporate bonds unless notified differently.

3. Corporate Bonds

Interest taxed at slab rate.

• Capital gains based on listed/unlisted classification.

4. Perpetual Bonds

Treated similar to corporate bonds for taxation.

5. Tier-1 / Tier-2 Instruments

Special rules apply depending on classification; interest typically taxed at slab rate.

Taxation of Government Securities

Government securities include:

• T-Bills

• Dated G-Secs

• SDLs

Taxation:

• Interest income fully taxable

• No TDS

• Gains taxed as per listed debt treatment

• T-Bills generate discount income, taxed as interest

G-Secs form a core part of India’s tax structure for sovereign instruments.

Taxation of Corporate Bonds

Corporate bonds follow standard taxation:

Interest Income

• Fully taxable

• TDS may apply

Capital Gains

Based on whether the bond is listed or unlisted.

Corporate bonds require careful review of offer documents for tax clauses.

Taxation of Municipal Bonds

Municipal bonds in India may fall into two categories:

1. Tax-Free Municipal Bonds

If explicitly notified, interest income may be exempt under designated sections.

2. Standard Municipal Bonds

Interest is taxable.

Capital gains apply as per listed or unlisted status.

Not all municipal bonds are tax-free — exemption applies only to notified issuances.

Taxation of Securitised & Structured Instruments

These include:

• Asset-Backed Securities (ABS)

• Mortgage-Backed Securities (MBS)

• Pass-Through Certificates (PTCs)

Tax treatment depends on:

• income pass-through rules

• structure of the SPV

• nature of underlying assets

• regulatory guidelines

Investors should refer to offer documents and regulatory notifications due to structural complexity.

Example: Understanding Bond Tax Calculations

Illustrative Example (Neutral, Non-Recommendatory)

A listed corporate bond has:

Face value: ₹100 Sale price: ₹105 Holding period: 14 months Since the bond is listed and held for > 12 months, the ₹5 gain falls under LTCG, taxed per listed security rules. If held for less than 12 months, the gain would be STCG, taxed at slab rate. This example is for educational understanding of tax calculation frameworks.

Common Mistakes Investors Should Avoid

Common errors include:

1. Assuming all bond income is tax-free

Only certain municipal bonds may have exemptions.

2. Confusing interest with capital gains

They are taxed differently.

3. Not checking listed vs unlisted status

This significantly impacts capital gains tax.

4. Ignoring TDS rules

TDS affects cash flow but not total liability.

5. Misinterpreting discount instruments

T-Bills are not “zero-tax”; the discount is taxed as interest.

Understanding these aspects supports accurate planning.

How BondScanner Helps With Transparent Tax Information

BondScanner provides:

• issuer details

• coupon and maturity terms

• security type

• listed/unlisted classification

• offer documents

• risk disclosures

These allow investors to understand bond characteristics clearly.

BondScanner does not provide tax advice or personalised investment recommendations.

Conclusion

Taxation plays a crucial role in evaluating bond structures.

Understanding how interest, capital gains, TDS, and listing status affect tax treatment helps investors interpret fixed-income instruments more accurately.

Different bonds—government, corporate, municipal, securitised—have distinct tax frameworks aligned with the Income Tax Act and relevant regulations.

Disclaimer

This blog is intended solely for educational and informational purposes. The bonds and securities mentioned herein are illustrative examples and should not be construed as investment advice or personal recommendations. BondScanner, as a SEBI-registered Online Bond Platform Provider (OBPP), does not provide personalized investment advice through this content.

Readers are advised to independently evaluate investment options and seek professional guidance before making financial decisions. Investments in bonds and other securities are subject to market risks, including the possible loss of principal. Please read all offer documents and risk disclosures carefully before investing.