Taxation of Bonds & Debentures in India
Taxation of Bonds & Debentures in India A practical guide to interest income, capital gains, TDS and special categories — updated for FY 2025-26 and the Income-tax Act, 2025 Bonds and debentures have quietly become one of the most popular ways for Indian investors to earn steady, predictable income — and for good reason. They’re less volatile than equity, often more rewarding than a fixed deposit, and today’s market gives you everything from government securities to corporate NCDs to sovereign gold bonds. But the return you actually keep depends on how well you understand the tax rules that sit underneath these instruments. This guide walks through exactly that — in plain language, with the current rates and thresholds you need for FY 2025-26 (AY 2026-27), and a look ahead at how things read under the new Income-tax Act, 2025. 1. First, the Building Blocks: Types of Bonds and Debentures Before getting into tax treatment, it helps to know what you’re holding. Indian debt instruments fall into a few overlapping categories, and the classification you fall into often decides which tax rule applies. By security Secured debentures: Backed by a charge on the issuer’s assets, so investors have a claim to recover money if the issuer defaults. Unsecured debentures: Backed only by the issuer’s creditworthiness, with no specific asset as collateral — typically offering a slightly higher coupon to compensate for the added risk. By convertibility Convertible debentures: Can be converted into equity shares of the issuing company after a specified period. Non-convertible debentures (NCDs): Popularly called NCDs, these repay only in cash and never convert into shares — the most common structure for corporate bond issuances. By listing status — the most tax-relevant distinction Listed bonds: Traded on a recognised stock exchange (BSE/NSE). This status matters enormously for tax purposes, as you’ll see shortly. Unlisted bonds: Privately placed or otherwise not traded on an exchange. Tax treatment here has become notably less friendly in recent years. Common instruments you’ll come across Corporate bonds / NCDs – issued by companies and financial institutions, may be listed or unlisted. Government securities (G-Secs) – issued by the Government of India and state governments, considered near risk-free. Tax-free bonds – issued historically by entities like NHAI, REC, PFC and IRFC, offering tax-exempt interest. Capital gain bonds – (rebranded as Section 85 bonds under the Income-tax Act, 2025) issued by REC, PFC, IRFC and NHAI specifically to help investors save capital gains tax. Sovereign Gold Bonds – (SGBs) issued by the RBI on behalf of the Government, denominated in grams of gold. RBI Floating Rate Savings Bonds, 2020 – a popular small-savings option carrying a floating coupon reset every six months. Perpetual bonds / AT1 bonds – issued mainly by banks and NBFCs to shore up capital; these carry no fixed maturity and higher risk. Zero-coupon bonds – issue at a discount and redeem at face value with no periodic coupon; the entire return is booked at maturity (or sale). Market-linked debentures (MLDs) – a category that has seen its tax treatment tightened considerably — more on this below. 2. Taxation of Interest Income This part is refreshingly simple: coupon or interest income from a bond or debenture is taxed as “Income from Other Sources” and added to your total income, taxed at your applicable slab rate. There’s no special concessional rate for interest, regardless of whether the bond is listed, unlisted, government-issued or corporate — with one notable exception discussed below. TDS on interest — Section 193 Under Section 193, tax is generally deductible at 10% on interest on securities, subject to specified thresholds and exemptions: Small-investor exemption: interest on debentures issued by companies and credited/paid through account payee cheque, where the aggregate does not exceed the prescribed threshold in a financial year, is exempt from TDS — though it remains fully taxable in your hands. Government securities: TDS is generally not deducted on interest from Central or State Government securities paid to resident holders, though the income is still taxable at slab rate. No-PAN penalty: if a valid PAN is not furnished, the deduction rate can rise to 20%. New declaration mechanism: from April 2026, a unified self-declaration form (Form 121) replaces the erstwhile Form 15G/15H, allowing eligible resident taxpayers whose total income is below the taxable threshold to avoid TDS at source. Tax-free bonds — the interest exemption Interest on notified tax-free bonds (issued historically by NHAI, REC, PFC, IRFC and similar entities) is fully exempt under Section 10(15). This is a genuine exemption — not merely a deferral — and no TDS is deducted, so you receive the full coupon. That said, this exemption applies only to interest. If you sell a tax-free bond in the secondary market before maturity and book a profit, that profit is a capital gain and is very much taxable under the rules discussed in the next section. Sovereign Gold Bonds Interest on SGBs (currently 2.5% per annum, paid semi-annually) is taxable at your slab rate, with no TDS deducted by the issuer. Capital gains, however, get special treatment — covered separately below. 3. Taxation of Capital Gains — Where Listing Status Really Matters If you sell a bond in the secondary market, or it matures at a value higher than your cost (as with a zero-coupon bond bought at a discount), the profit is a capital gain. This is where the listed-versus-unlisted distinction becomes the single most important factor in your tax outcome, especially after the changes introduced by the Finance (No. 2) Act, 2024. Listed bonds and debentures Held for 12 months or less (short-term): gain is added to your total income and taxed at slab rate. Held for more than 12 months (long-term): taxed at a flat 12.5%, with no indexation benefit available. Unlisted bonds and debentures — always short-term now This is the change that catches many investors off guard. Under Section 50AA, capital gains from unlisted bonds, unlisted debentures, and market-linked debentures (MLDs) transferred, redeemed or maturing on or after