Corporate bonds which is issued by companies to raise capital are a popular investment avenue offering periodic interest and principal repayment. Under the Income Tax Act, 1961, the taxation of corporate bonds includes distinct treatments of interest income and capital gains, influenced by factors such as the bond's listing status and holding period. Interest is taxed at the investor's slab rate with TDS provisions, while capital gains are classified as short-term or long-term, taxed at varying rates.
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Taxation of Corporate Bonds Under Income Tax Act, 1961
Corporate bonds are debt instruments which are issued by companies to raise capital, offering periodic interest payments (coupons) and principal repayment at maturity. Unlike government securities, corporate bonds are generally taxable with taxation governed by the Income Tax Act, 1961. The tax treatment varies based on the nature of income (interest or capital gains) and whether the bond is listed or unlisted on recognized stock exchanges.
Taxation of Interest Income
Interest income from corporate bonds is classified under "Income from Other Sources" as per the Income Tax Act, 1961. Key details include:
Taxability: The interest is added to the investor's gross total income and taxed at their applicable slab rate, which ranges from 5% to 30%, plus surcharge and cess, depending on total income and tax regime (old or new). For example: If an investor earns INR 20,000 interest from a corporate bond and falls in the 30% tax slab (old regime, income > INR 10,00,000), the tax on interest would be INR 6,000 (30% of 20,000), plus cess.
Accrual vs. Receipt Basis: Investors can choose to offer interest on a receipt basis or accrual basis, but consistency is required. For cumulative bonds (where interest is paid at maturity), offering on an accrual basis is advisable to spread tax liability and avoid a large tax burden at redemption.
Zero-Coupon Bonds: These bonds, issued at a discount and redeemed at face value, do not pay periodic interest. The difference between the issue price and face value is treated as capital gains, not interest, and taxed accordingly (see Capital Gains section).
Tax Deducted at Source (TDS)
Rate and Applicability: As per Section 193 of the Income Tax Act, 1961, TDS is deducted at 10% on interest income from both listed and unlisted corporate bonds if it exceeds INR 5,000 annually. This rule was reinforced by Budget 2023 amendments, effective from April 1, 2023, under Section 193(ix) for resident Indians with linked PAN and Aadhar.
Avoidance: Investors can avoid TDS by submitting Form 15G (for individuals below 60 years) or Form 15H (for individuals above 60 years) at the start of the financial year, provided their income is below the taxable threshold.
Impact: TDS ensures regular tax collection and simplifies compliance but investors should account for it when planning cash flows.
Taxation of Capital Gains
Capital gains arise from the sale or redemption of corporate bonds before maturity with tax treatment depending on the holding period and listing status. The following table summarizes the key parameters:
Holding Period:
For listed corporate bonds, the holding period to qualify as a long-term capital asset is more than 12 months aligning with equity and other listed securities.
For unlisted corporate bonds, the holding period is generally more than 36 months, reflecting their illiquidity and higher risk profile.
Tax Rates:
Short-Term Capital Gains (STCG): Gains from bonds held for less than the respective long-term period (12 months for listed, 36 months for unlisted) are taxed at the investor's slab rate, ranging from 5% to 30%, plus surcharge and cess.
Long-Term Capital Gains (LTCG):
Listed bonds: Taxed at a flat 10% without indexation benefit, as per recent interpretations.
Unlisted bonds: Taxed at a flat 20%, reflecting higher risk and lack of market liquidity.
Computation of Gains:
Short Term Capital Gains: Calculated as the difference between the sale/redemption price and the cost of acquisition, taxed at slab rates.
Long Term Capital Gains: For unlisted bonds, the cost of acquisition cannot be indexed for inflation except for specific instruments like Capital Indexed Bonds or Sovereign Gold Bonds which are not corporate bonds.
Special Considerations:
For non-resident investors, any appreciation due to rupee depreciation in rupee-denominated corporate bonds is not taxable, providing a tax advantage.
Tax-free bonds, often issued by government entities or PSUs, are not applicable to corporate bonds, as corporate bond interest is always taxable.
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Additional Tax Provisions and Exemptions
Understanding the tax provisions and exemptions for corporate bonds is crucial for optimizing returns and minimizing tax liabilities. These rules are primarily governed by the Income Tax Act and outline specific conditions for capital gains taxation and potential exemptions. Unlike government bonds, corporate bonds have limited tax-saving benefits and making strategic planning essential for investors.
Indexation Benefit: Unlike some government securities (e.g., Capital Indexed Bonds), corporate bonds do not qualify for indexation benefits, meaning the cost of acquisition cannot be adjusted for inflation, potentially increasing tax liability on LTCG.
Tax Exemptions: Investors can claim exemption under Section 54F for Long Term Capital Gains from corporate bonds if the proceeds are reinvested in a residential house, subject to conditions such as not owning more than one residential property at the time of sale and investing within specified timelines. This is particularly beneficial for substantial gains.
Tax-Saving and Tax-Free Bonds: These are typically issued by government or PSU entities (e.g., 54EC bonds, infrastructure bonds), not corporates. Corporate bonds do not offer tax-free interest, and tax-saving benefits are limited to specific government schemes.
Summary
The taxation of corporate bonds under the Income Tax Act, 1961, is comprehensive, covering interest at slab rates with TDS, and capital gains based on holding period and listing status. Listed bonds offer a lower LTCG rate (10%) with a shorter holding period (12 months), while unlisted bonds face a higher LTCG rate (20%) with a longer holding period (36 months). No indexation benefit and no tax-free interest distinguish corporate bonds from government securities and make tax planning crucial for investors.
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Taxation of Corporate Bonds: FAQs
Q1. How is the interest income from corporate bonds taxed under the Income Tax Act, 1961?
Interest from corporate bonds is taxed as "Income from Other Sources" at the investor's applicable income tax slab rate (5% to 30%, plus surcharge and cess). TDS at 10% is deducted if annual interest exceeds INR 5,000, unless exempted via Form 15G/15H.
Q2. What is the difference in capital gains taxation for listed and unlisted corporate bonds?
For listed bonds, long-term capital gains (LTCG) apply after 12 months, taxed at 10% without indexation. For unlisted bonds, LTCG applies after 36 months, taxed at 20%. Short-term capital gains (STCG) are taxed at slab rates for both.
Q3. Can I avoid TDS on corporate bond interest, and how?
Yes, TDS can be avoided by submitting Form 15G (for individuals under 60) or Form 15H (for those over 60) at the start of the financial year, provided your income is below the taxable threshold.
Q4. Are there any tax exemptions available for capital gains from corporate bonds?
Long-term capital gains from corporate bonds can be exempt under Section 54F if reinvested in a residential house, subject to conditions like not owning multiple properties and meeting investment timelines.
Q5. Do corporate bonds offer tax-free interest or indexation benefits?
No, corporate bonds do not offer tax-free interest, unlike certain government or PSU bonds. Indexation benefits are also unavailable, except for specific instruments like Capital Indexed Bonds, which are not corporate bonds.
