How Much Tax is Paid on Bond Investment?


Taxable bonds are great investments. They’re relatively low-risk, provide income in the form of interest, and offer a guaranteed return when you purchase them. But what happens if you sell the bond before it matures?

When deciding how much of their portfolio to invest in bonds, traders consider several things, including coupon payments, lock-in periods, etc. However, tax on bonds is the single most crucial consideration when buying these financial instruments.

Before making a bond investment, it’s important to understand the potential benefits and tax implications, as these factors vary depending on the bond’s composition and the length of time it will be held.

Taxation of Bonds

There are two methods for bondholders to profit from their investments: interest and appreciation in value.

Unless otherwise stated, bond interest is usually taxed. If a bond were tax-exempt or eligible for capital gains exclusion, its name would reflect that.

Taxable Bond

Taxable bonds are debt securities whose yield to the investor is taxed at either the state or federal level. When deciding between a taxable bond and a tax-exempt bond, investors should consider their after-tax income.

The interest charged on a corporate bond is taxable, as are any capital gains or losses realized from selling the bond early, and any original issue discount received is also taxable. A corporate bond’s overall tax liability is the sum of its constituent parts’ individual tax liabilities.

  1. Interest: Income earned from a company bond is taxable at federal and state levels. Generally speaking, this tax rate applies to a typical corporate bond.
  1. Capital Gains: Capital gains taxes are less common than interest taxes since an investor can only realize capital gains on a corporate bond by selling the bond before maturity. Until the bond reaches maturity, any gain from selling it is considered capital gain and must be taxed at the investor’s regular income tax rate.
  1. Issue Discount: It is not uncommon for bonds to be issued at a price well below their face value. The tax liability associated with the original issue discount resulting from the purchase of a zero coupon bond is the amount by which the offer price exceeds the bond’s par value.

Regular Taxable Bonds

The word “tax” in these bonds should give you a clue about their status. These bonds offer the opportunity for both capital gains and interest. When an investment matures, the investor reaps capital gains. Capital gains are the profit made from selling an asset, such as a bond, over and above the initial investment.

Any profit from selling these bonds can be classified as either long-term or short-term. If you hold listed bonds for longer than a year, you will receive LTCG on your realized returns. Investors who sell bonds after holding them for less than a year pocket short-term capital gains. Both short-term and long-term capital gains are subject to taxation; however, the former is taxed at 10 per cent without indexation.

Any profits made from the sale of unlisted bonds after a holding period of more than three years are considered long-term capital gains. With no adjustments for inflation, the tax rate is 20%. Gains from investments held for less than 36 months are subject to taxation as short-term capital gains at the individual’s marginal tax rate.

Tax-Free Bonds

These bonds are issued by governments and public-sector organizations (PSUs) to fund many important initiatives. Highways, trains, ports, urban and rural development, etc., are all funded thanks to tax-free bonds issued by the government.

The interest earned on these investments is tax-free for the investor. However, depending on how long you keep onto the bonds before they mature or are sold. The income you receive from them will be treated as either a long-term capital gain or a short-term capital loss.

Features Of Tax-Free Bonds

These bonds accrue interest once yearly at a rate set by the federal government. None of the interest you earn will be subject to taxes.

Government bonds that don’t incur taxes are typically purchased for a very long time horizon. You can choose a bond maturity of 10, 15, or 20 years according to your preferences.

These bonds are highly liquid, meaning they can be bought and sold at any moment at the current market price. However, under the IT Act, you will be required to pay taxes on any gain from selling these bonds.

Bonds can be held either physically or digitally. You can make a direct transaction or use your Demat account to purchase.

Tax-Saving Bonds

The government’s tax-saving bond program is a fantastic resource for those looking to set money aside for future tax obligations. The Income Tax Act recognizes them as unique papers that may be used to reduce a taxpayer’s taxable income. This bond is subject to a 5-year lock-in requirement.

Anyone who owns a piece of real estate, a building, or another long-term capital asset can invest in these bonds and reduce their taxable income. The money they get from selling these things can be put into 54EC bonds. An investor in these bonds will pay no long-term capital gains tax.

However, the 6-month waiting period between the sale and the investment is non-negotiable if you want to take advantage of this tax benefit. There is the potential for capital gains for investors. Long-term capital gains are taxed differently than short-term ones.

The government also provides annual deductions for investments of up to Rs. 20,000. This amount exceeds the Rs. 1.5 lakh limit u/s 80C allows for tax savings.

NHAI, REC, and PFC can issue 54EC bonds.

Zero-Coupon Bonds

When you purchase a bond, you will get regular interest payments or coupons at regular intervals. When issued, zero-coupon bonds are typically sold at a steep discount because of their lack of interest payments. When the investment matures, the investor will receive the full face value.


Bonds are a safer investment option because of their consistent and predictable yields. Before jumping in, investors should research how different bonds are taxed and how the laws might change. We hope you have an improved grasp of RBI Taxable Bonds techniques for your financial goals. The article has provided a detailed preview of how various taxable bonds are taxed.  

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