Taxation of debentures, bonds and units of debt oriented mutual funds

Capital gains

The gains arising on transfer of the above shall be taxed under the head 'Capital Gains'. The relevant provisions in this regard are as follows:

1. Section 2(42A)

• If a listed security is held for more than 12 months it will be considered as a 'Long term capital asset'. This means if it is held for 12 months or less it'll be termed as 'Short term capital asset'.
• If unlisted debentures or bonds and units of debt oriented mutual funds are held for more than 36 months they'll be considered as 'Long term capital assets'. This means if they're held for 36 months or less they'll be termed as 'Short term capital assets'.

Note: Period of holding refers to the time span for which an asset is held by a person, immediately prior to its transfer. It shall be computed from the date on which the asset was acquired until the date of its transfer.

(In case the asset is acquired other than by means of acquisition, the period of holding shall be reckoned as per various provisions of the Income Tax Act, 1961)

2. Third Proviso to Section 48

This proviso states that indexation shall not apply to the long-term capital gain arising from the transfer of bonds or debentures.

However, it shall apply to -

• Capital indexed bonds issued by the Government
• Sovereign Gold Bond issued by the Reserve bank of India under the Sovereign Gold Bond Scheme, 2015

Note: Indexation is not applicable to any short-term capital gains.

3. Section 112

The tax payable on long-term gains (LTCG) arising from transfer of:

a. Listed debentures and bonds (except 2a and 2b) shall be lower of-

• 20% of LTCG without giving effect of indexation
• 10% of LTCG without giving effect of indexation

Thus, the LTCG in this case shall always be taxed at 10% without indexation.

b. Unlisted debentures and bonds (except 2a and 2b) shall be-

20% of LTCG without giving effect of indexation

c. Units of debt oriented mutual funds shall be-

20% of LTCG after giving effect of indexation

4. Section 111A

Short-term gains (STCG) arising from transfer of all of these shall be taxable at the normal slab rates applicable to the person.

5. Summary

Taxation of capital indexed bonds issued by the government and sovereign gold bonds issued by RBI

1. The tax payable on long-term gains (LTCG) arising from transfer of these being:

A. Listed bonds shall be lower of-

• 20% of LTCG after giving effect of indexation
• 10% of LTCG without giving effect of indexation

B. Unlisted bonds shall be-

• 20% of LTCG after giving effect of indexation

2. Short-term gains (STCG) arising from transfer of all of these shall be taxable at the normal slab rates applicable to the person.

Investment in capital gain bonds for availing capital gain exemption u/s. 54ec

In order to claim Capital Gains exemption u/s. 54EC, one needs to invest the gains amount in NHAI or RECL bonds, redeemable after five years, within a period of six months after date of transfer. The maximum amount of investment that can be made for this purpose is ₹ 50,00,000.

Income from other sources

Interest from debentures and bonds is taxable under the head 'Income from Other Sources'. It shall be taxed as per normal slab rates. If any reasonable expenditure such as commission or remuneration is incurred for realizing such interest, it can be claimed as a deduction.

Dividend from units of debt oriented mutual funds shall be exempt from tax.

Tax free bonds

Income by way of interest on these bonds is fully exempt from Income Tax under section 10(15)(iv)(h) of the Income Tax Act, 1961.

There are many public undertakings that offer and issue tax-free bonds. National Highway Authority of India, NTPC Limited and Indian Railways, Rural Electrification Corporation, Housing and Urban Development Corporation, Indian Renewable Energy Development Agency, Rural Electrification Limited and Power Finance Corporation are some of these.

References:

The Income Tax Act, 1961