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Income Tax on Bonds and Debentures

by | May 1, 2024 | Income Tax | 0 comments

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Important Keyword: Bonds & Debentures, Capital Gains, ITR-2, Trading Income.

Income Tax on Bonds and Debentures

Governments and companies often resort to issuing Bonds & Debentures as a means of raising funds. Bonds are commonly utilized by governments to borrow money from the public, as they cannot directly take loans from individuals. On the other hand, companies issue debentures to gather funds from investors. These financial instruments serve as avenues for enhancing liquidity and bolstering working capital for both entities.

Meaning of Bonds and Debentures

Bonds

Bonds serve as financial tools issued by governments, municipalities, or corporations with the aim of raising funds. When an entity issues a bond, it essentially borrows money from investors who purchase these securities. In return, the issuer commits to repaying the bond’s principal amount at a specific future date, termed the maturity date. Additionally, the issuer agrees to make periodic interest payments, referred to as coupon payments, at a predetermined interest rate until the bond reaches maturity.

As fixed-income securities, bonds offer a reliable income stream through their interest payments. They are actively traded in financial markets and are generally perceived as safer investments in comparison to stocks due to their fixed income and lower risk of default.

Debentures

Debentures serve as financial instruments utilized by corporations or governments to secure funds. When a company issues debentures, it effectively borrows money from investors who purchase these instruments. Unlike bonds, debentures lack specific asset collateral from the issuing company, relying solely on the issuer’s creditworthiness for security.

Typically, debentures offer a fixed interest rate and have a designated maturity date. Upon reaching maturity, the issuer is obligated to repay the principal amount to the debenture holders. Debentures represent a popular avenue for companies to acquire long-term capital, often employed to support expansion endeavors or other corporate initiatives.

Types of Bonds and Debentures

There are various types of Bonds and debentures mentioned below:

BondsDebentures
Regular taxable bondSecured/Unsecured debenture
Tax-free bondsConvertible/Non-convertible debentures
Tax-saving bondsRedeemable/Non-redeemable debentures
Zero coupon bondsFixed-rate/Floating-rate debentures

Income Heads for Income from Bonds and Debentures

Capital Gains on Sale of Bonds and Debentures

When investors decide to sell or redeem their bonds or debentures, any resulting profits are subject to taxation categorized as Capital Gains. The tax rates levied on these gains are contingent upon the duration for which the assets were held.

Type of AssetPeriod of HoldingCapital Gains
Listed Bonds & Debentures<= 12 monthsShort-Term Capital Gains
Listed Bonds & Debentures> 12 monthsLong-Term Capital Gains
Unlisted Bonds & Debentures<= 36 monthsShort-Term Capital Gains
Unlisted Bonds & Debentures> 36 monthsLong-Term Capital Gains

IFOS Income from Bonds and Debentures

Interest income generated from bonds and debentures falls under the category of ‘Income from Other Sources,’ abbreviated as IFOS. This income is subject to taxation at slab rates. Moreover, if the taxpayer has incurred expenses such as commissions, fees, or remuneration to realize this interest, they can claim it as a deduction from the interest income.

However, interest income derived from tax-free bonds enjoys full exemption from taxation. Therefore, when filing Income Tax Returns (ITR), interest income from tax-free bonds must be reported under Schedule Exempt Income. Tax-free bonds are issued by public undertakings such as the National Highway Authority of India, Rural Electrification Corporation, NTPC Limited, Indian Railways, Indian Renewable Energy Development Agency, Housing and Urban Development Corporation, Power Finance Corporation, and Rural Electrification Limited.

Income Tax on Bonds and Debentures

Income tax on trading in bonds and debentures follows a similar tax treatment as other capital assets. The applicable tax rates are as follows:

Income Tax on Sale of Bonds and Debentures

Type of AssetCapital GainsTax Rate
Listed/Unlisted Bonds & DebentureShort-Term Capital GainsSlab rate
Listed/Unlisted Bonds & DebentureLong-Term Capital GainsFor Listed Bonds & Debentures:
10% without Indexation under Section 112

For Unlisted Bonds & Debentures:
20% without Indexation under Section 112

Please note that taxpayers cannot avail themselves of indexation benefits for Long Term Capital Gains (LTCG) on the sale of Bonds or Debentures. However, indexation benefits are applicable to Capital Indexed Bonds issued by the Government and Sovereign Gold Bonds issued by the RBI under the Sovereign Gold Bond Scheme, 2015.

Income Tax on Other Income from Bonds and Debentures

Interest income from Bonds & Debentures is taxed according to slab rates. Typically, interest on bonds is taxable, but interest income from tax-free bonds is exempt from tax.

Investors considering tax-free bonds should calculate the pre-tax yield before making investment decisions. To calculate the pre-tax yield, use this formula – ROI / (100-TR) * 100. (TR represents Taxable Rate)

For example, if tax-free bonds offer an interest rate of 5% and the investor falls into a 30% tax slab, the effective tax rate would be 30% + 4% Cess = 31.2%. Calculating the pre-tax yield would result in 5% / (1-31.2%) = 7.16%. This means that for an investor paying 31.2% tax, investing in a taxable bond with 7.16% interest is equivalent to investing in a tax-free bond with 5% interest.

Capital Gains Exemption under Section 54EC allows individuals who have sold Long Term Capital Assets such as land or buildings to claim exemption by investing in NHAI, REC, PFC, or IRFC Bonds. The amount of exemption will be the lower of the capital gain invested in bonds or INR 50 lakhs. This provision helps taxpayers reduce their tax liability.

When filing Income Tax Returns (ITR), investors must use ITR-2, which is specifically for reporting income from capital gains, as the sales or redemption income from bonds and debentures are treated as Capital Gains. The due date for filing ITR-2 is the 31st of July.

How to Report Income in ITR

When reporting gains or losses from bonds and debentures in the Income Tax Return (ITR), taxpayers must file ITR-2 and report them under the head “Income from Capital Gains.” In Schedule CG, the incomes or losses should be reported in the following sections:

For Short-Term Capital Gains-
For Long-Term Capital Gains-

In this section, enter the sales amount as the full value of consideration, representing the proceeds received from selling the bonds or debentures. Under the cost of acquisition, input the purchase value, indicating the original cost incurred to acquire the bonds or debentures.

Carry Forward Loss from the Sale of Bonds & Debentures

Let’s delve into an illustrative scenario involving Mr. Rahul, a salaried individual who ventured into investing in listed bonds and debentures during the fiscal year 2023-24. With a total annual salary income of INR 8,70,000, Mr. Rahul encountered a Short Term Capital Loss of Rs. 30,000 and a Long Term Capital Gain of INR 1,50,000 from his investment endeavors.

To fulfill his tax obligations for the fiscal year 2023-24, Mr. Rahul must file his Income Tax Return using Form ITR-2. Let’s break down his total income and tax liability:

  1. Total Income:
    • Salary Income: INR 8,70,000
    • Short Term Capital Loss: Rs. 30,000
    • Long Term Capital Gain: INR 1,50,000
  2. Tax Liability:
    • Mr. Rahul can set off his Short Term Capital Loss of Rs. 30,000 against both Short Term Capital Gain and Long Term Capital Gain.
    • For the remaining loss after set-off, he can carry it forward for up to 8 years to set off against future gains.
    • However, his Long Term Capital Loss can only be set off against Long Term Capital Gain, not against his salary income or Short Term Capital Gain.
    • Similar to the Short Term Capital Loss, any remaining Long Term Capital Loss can also be carried forward for 8 years.
    • By accurately reporting his capital gains and losses in his ITR-2, Mr. Rahul can ensure compliance with tax regulations and optimize his tax liability.
ParticularsAmount (INR)Amount (INR)
Income from Salaries8,70,000
Income from Capital Gains:
Short-Term Capital Loss(30,000)
Long-Term Capital Gains1,50,000
Total Capital Gains after set-off of losses
(taxable @10% without indexation)
1,20,000
Total Taxable Income9,90,000
Tax at Normal Rates8,65,00
Tax at Special Rate12,000
Total Income Tax98,500
Health and Education Cess @4%3,940
Net Tax Liability1,02,440

Read More: Capital Gains Account Scheme (CGAS)

Web Stories: Capital Gains Account Scheme (CGAS)

Official Income Tax Return filing website: https://incometaxindia.gov.in/

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