Just as individuals obtain loans and borrowings for financial support, governments, and companies have the option to raise funds by issuing bonds and debentures, respectively. Unlike individuals, governments cannot directly take loans from individuals, so they utilize various types of bonds to raise capital from the general public. Similarly, companies issue various types of debentures to gather funds from their investors. Through the issuance of bonds and debentures, both entities can enhance their liquidity and working capital.
Meaning of Bonds & Debentures
Bonds
Bonds are financial instruments issued by governments, municipalities, or corporations to raise funds. When an entity issues a bond, they are essentially borrowing money from investors who buy the bonds. In return, the issuer promises to repay the principal amount of the bond at a specific future date, known as the maturity date. Additionally, they agree to pay periodic interest payments, known as coupon payments, at a predetermined interest rate until the bond matures.
Bonds are considered fixed-income securities because they provide a steady stream of income through interest payments. They are frequently traded in financial markets and are generally considered safer investments compared to stocks due to their fixed income and lower risk of default.
Debentures
Debentures are financial instruments that corporations or governments use to raise funds. By issuing debentures, a company is essentially borrowing money from investors who buy the debentures. Unlike bonds, debentures are not secured by specific assets of the issuing company. This means that they are backed only by the issuer’s creditworthiness.
Debentures usually pay a fixed rate of interest and have a specified maturity date. At this point, the issuer must repay the principal amount to the debenture holders. Debentures are a common way for companies to raise long-term capital and are often used to finance expansion projects or other business initiatives.
Types of Bonds & Debentures
There are various types of Bonds and debentures mentioned below:
| Bonds | Debentures |
| Regular taxable bond | Secured/Unsecured debenture |
| Tax-free bonds | Convertible/Non-convertible debentures |
| Tax-saving bonds | Redeemable/Non-redeemable debentures |
| Zero coupon bonds | Fixed-rate/Floating-rate debentures |
Income Heads for Income from Bonds & Debentures
Capital Gains on Sale of Bonds & Debentures
Whenever an investor sells or redeems their bonds or debentures, any profits received are subject to taxation under the category of Capital Gains. The tax rates applied to these gains depend on the duration for which the assets were held.
| Type of Asset | Period of Holding | Capital Gains |
| Listed Bonds & Debentures | <= 12 months | Short-Term Capital Gains |
| Listed Bonds & Debentures | > 12 months | Long-Term Capital Gains |
| Unlisted Bonds & Debentures | <= 36 months | Short-Term Capital Gains |
| Unlisted Bonds & Debentures | > 36 months | Long-Term Capital Gains |
IFOS Income from Bonds & Debentures
Interest Income from Bonds and Debentures is taxable under the head ‘Income from Other Sources‘ i.e. IFOS. Further, the Interest Income is taxed at slab rates. Additionally, If the assessee has incurred an expense such as commission or fees, remuneration, etc to realize such Interest, then it can be claimed as a deduction from the Interest Income.
However, interest income from Tax-free bonds is fully exempt. Hence, the interest income from tax-free bonds needs to be reported under schedule Exempt Income while filing ITR.
Note: Tax-free bonds are the bonds issued by public undertakings like the National Highway Authority of India, Rural Electrification Corporation, NTPC Limited and Indian Railways, Indian Renewable Energy Development Agency, Housing and Urban Development Corporation, Power Finance Corporation, and Rural Electrification Limited.
Income Tax on Bonds & Debentures
Income Tax on Trading in Bonds & Debentures is similar to the tax treatment of other capital assets. The following are the income tax rates:
Income Tax on Sale of Bonds & Debentures
| Type of Asset | Capital Gains | Tax Rate |
| Listed/Unlisted Bonds & Debenture | Short-Term Capital Gains | Slab rate |
| Listed/Unlisted Bonds & Debenture | Long-Term Capital Gains | For Listed Bonds & Debentures: 10% without Indexation under Section 112 For Unlisted Bonds & Debentures: 20% without Indexation under Section 112 |
Note: Assessee cannot take benefit of indexation for the Long Term Capital Gain (LTCG) on the sale of Bonds or Debentures. However, the indexation benefit is available on 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 & Debentures
Interest Income from Bonds & Debentures is taxed as per slab rates. Usually, the interest on bonds is taxable income. However, in the case of tax-free bonds, the interest income is exempt from tax.
An investor who invests in tax-free bonds should calculate the pre-tax yield before making the investment decision. To calculate the pre-tax yield, use this formula – ROI / (100-TR) * 100. (TR means Taxable Rate)
Example
Tax-free bonds have an interest rate of 5%. Let us assume that the investor falls in a tax slab of 30%. Whether he/she invests in the tax-free bond?
Effective Tax Rate – 30% + 4% Cess = 31.2%
Calculate the pre-tax yield = 5% / (1-31.2%) = 7.16%
Thus, for an investor who pays 31.2% tax, investing in a taxable bond with 7.16% interest is the same as investing in a tax-free bond with 5% interest.
Capital Gains Exemption under Section 54EC
An assessee who has sold Long Term Capital Assets like land or building or both can claim exemption by investing in NHAI, REC, PFC, or IRFC Bonds. The amount of exemption will be lower of the following:
- The amount of capital gain invested in bonds
- INR 50 lakhs
The taxpayer can claim the capital gain exemption under Section 54EC to reduce the tax liability.
ITR Form and Due Date
- ITR Form: The investor has to file ITR-2 (ITR for Capital Gains Income) as the sales or redemption income from bonds and debentures are treated as Capital Gains.
- Due Date: The 31st of July is the due date for filing ITR-2.
How to Report Income in ITR
The taxpayer has to report gains or losses from bonds and debentures under the head Income from Capital gains and they have to file ITR-2. In Schedule CG, the incomes or losses will be reported in the following section:
For Short-Term Capital Gains-
For Long-Term Capital Gains-
Here, in the full value of consideration, the sales amount will be entered and under the cost of acquisition, the purchase value needs to be entered.
Carry Forward Loss from the Sale of Bonds & Debentures
- Short Term Capital Loss (STCL) can be set off against both Short Term Capital Gain (STCG) and Long Term Capital Gain (LTCG). Further, the remaining loss can be carried forward for 8 years and set off against both STCG and LTCG.
- Long Term Capital Loss (LTCL) can be set off against Long Term Capital Gain (LTCG) only. The remaining loss can be carried forward for 8 years and set off against LTCG only.
Example for capital gains on sale of bonds & debentures
For example, Mr. Rahul is a salaried individual and has invested in listed bonds and debentures in FY 2023-24. His total salary income for a year is INR 8,70,000. And has Short Term Capital Loss of Rs. 30,000 and Long Term Capital Gain of INR 1,50,000.
Now in the above example, Rahul needs to file ITR-2 for FY 2023-24. His total income and tax liability will be as follows:
| Particulars | Amount (INR) | Amount (INR) |
| Income from Salaries | 8,70,000 | |
| Income from Capital Gains: | ||
| Short-Term Capital Loss | (30,000) | |
| Long-Term Capital Gains | 1,50,000 | |
| Total Capital Gains after set-off of losses (taxable @10% without indexation) | 1,20,000 | |
| Total Taxable Income | 9,90,000 | |
| Tax at Normal Rates | 8,65,00 | |
| Tax at Special Rate | 12,000 | |
| Total Income Tax | 98,500 | |
| Health and Education Cess @4% | 3,940 | |
| Net Tax Liability | 1,02,440 |
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FAQs
The investor should file ITR-2 and report income from the sale of Bonds and Debentures as Capital Gains.
When the investor receives interest from bonds, they have to reflect it as interest income under head IFOS. On the sale or redemption of such bonds, capital gains will arise and investors have to pay taxes based on the holding period i.e. long-term or short-term.
If the bonds are purchased at a discounted price and redeemable at par are held till maturity then the difference between invested value and redemption value will be taxed under income from capital gains. Whereas, when the bonds are purchased and redeemable at par are held till maturity then no capital gain shall arise on redemption in this case.
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