Tax on Bonds: Understand How are Bonds Taxed in India
- PRITI SIRDESHMUKH
- 3 hours ago
- 15 min read
Bonds are one of the safest ways to grow money slowly and steadily. When you buy a bond, you are basically lending money to the government or a company for a fixed time. In return, you get interest regularly and your money back when the bond matures.
Most people think bond income is always tax-free. That is not true. The tax on bonds in India depends on what kind of bond you have, how long you keep it, and how you earn from it. Some bonds are fully taxable, while some are partly or fully exempt.
Let’s understand how bond taxation works in India in very simple words so you can plan your taxes better and avoid mistakes while filing your ITR.
Table of Contents
Overview of Tax on Bonds
Bonds are a way for the government or companies to borrow money from people. They collect funds from investors like you and pay them interest in return.
There are different types of bonds in India, such as:
Corporate Bonds issued by companies,
Government Bonds issued by the government,
Tax-Free Bonds that give tax-free interest, and
Tax-Saving Bonds that help reduce your tax on property sale profits.
Some bonds pay interest every few months or once a year. These are called coupon-bearing bonds.
Others do not pay any interest during their life. They are sold at a lower price and redeemed at full value later. These are called zero-coupon bonds. The profit you make when they mature is considered your income.
There are also market-linked bonds that depend on how the stock market performs, and sovereign gold bonds that depend on the price of gold.
How Tax on Bonds Work?
A bond is like a loan that you give to someone, like the government or a company.
When they need money, instead of borrowing from a bank, they borrow it from people like you. In return, they promise to pay you interest and return your full money after a few years.
So, when you buy a bond, you are lending money and becoming the lender. The company or government becomes the borrower.
There are a few simple words you should know:
Face Value: The amount you lend. For example, if you buy a ₹1,000 bond, that is the face value.
Coupon Rate: The interest you earn every year. If the coupon is 10%, you get ₹100 every year for every ₹1,000 you invested.
Maturity: The date when you get back your money.
Yield: The actual return you earn from the bond, which includes both interest and any extra profit from selling it.
Holding Period: How long you keep the bond before selling or redeeming it.
You can earn from bonds in two main ways:
Interest Income — the money you receive regularly for lending.
Capital Gains — if you sell your bond before it ends and make a profit.
So, in simple words, bonds are like giving your money on rent. You get rent (interest) for a few years and then get your money back when the agreement ends.
Types of Bonds in India
Now let us understand each bond type and how tax applies to it under the new 2025 rules.
1. Taxable Bonds
These are the most common bonds in India. The interest you earn from them is fully taxable under "Income from Other Sources". That means you add it to your total income and pay tax as per your slab rate. For example, if you are in the 20% tax slab and earn ₹50,000 as bond interest, you pay ₹10,000 as tax. If you sell or redeem your bond before it matures and make a profit, that profit is called capital gain.
Here is how it is taxed:
If your bond is listed on an exchange and you sell it after keeping it for at least 12 months, you pay 12.5% long-term capital gains tax.
If it is unlisted, then from 23 July 2024, there is no long-term capital gains benefit anymore. All gains are treated as short-term and taxed at your slab rate.
Common examples of taxable bonds are RBI Bonds, PSU Bonds, and Corporate Bonds.
2. Tax-Free Bonds
These are bonds issued by government-backed organisations like NHAI, REC, and PFC. The special thing about these bonds is that the interest you earn is completely tax-free under Section 10(15)(iv)(h). If you earn ₹1,00,000 as interest from a tax-free bond, you don’t pay any tax on it. But you should still mention it in your ITR under the "Exempt Income" section.
However, if you sell the bond before maturity and make a profit, that profit is taxable:
If you sell it within 12 months, tax is at your slab rate.
If you sell it after 12 months, tax is 12.5% as long-term capital gains.
So, tax-free bonds are great for people who want safe, steady income without paying tax on interest.
3. Tax-Saving Bonds (Section 54EC)
These bonds are mainly for people who have sold a property and earned capital gains. If you invest that capital gain in NHAI, REC, or PFC 54EC Bonds within six months, you can save tax on those capital gains. You can invest up to ₹50 lakh in a financial year, and you must keep the investment for five years. The main capital gain becomes tax-free, but the interest you earn from these bonds is taxable as per your slab. These are good options if you have recently sold a property and want to reinvest to save tax.
4. Zero-Coupon Bonds
Zero-coupon bonds do not pay interest every year. Instead, they are sold at a lower price and redeemed later at the full amount. The difference between what you paid and what you get back is your profit. For example, if you buy a bond for ₹80,000 and get ₹1,00,000 at maturity, your profit is ₹20,000. That profit is taxed as capital gain. If your zero-coupon bond is listed and you hold it for at least 12 months, the gain is long-term and taxed at 12.5%. If it is unlisted, from 23 July 2024, it will always be short-term, and the gain is taxed at your slab rate. Before this date, unlisted bonds that were held for more than 36 months were taxed at 20% with indexation. This rule no longer applies.
5. Corporate Bonds
Corporate bonds are issued by private companies and public sector undertakings. They usually offer higher interest than government bonds, but they also carry a bit more risk. The interest you earn is taxable as per your income slab. When you sell these bonds, the tax depends on how long you kept them and whether they were listed on an exchange.
For listed corporate bonds, if you hold them for at least 12 months, your profit is long-term and taxed at 12.5%.
For unlisted corporate bonds, any gain after 23 July 2024 is always short-term and taxed at your slab rate.
You can also adjust any loss from these sales against other capital gains under Section 70 or 71 to reduce your total tax.
6. Government Bonds
These bonds are issued by the central or state government and are considered the safest type of bonds in India. The interest you earn is taxable as regular income under "Other Sources". If you sell a listed government bond after holding it for 12 months or more, your profit is a long-term gain and taxed at 12.5%. Sovereign Gold Bonds (SGBs) are a special type of government bond linked to gold prices. They give 2.5% interest every year, which is taxable as per your slab. But the best part is that if you hold them till maturity after eight years, the capital gain you make is completely tax-free under Section 47(viic). These are perfect for safe investors who want predictable returns and minimal tax surprises.
How to Calculate Tax on Bonds (with Examples)
Calculating tax on bonds is not as complicated as it sounds. The tax depends mainly on two things,— how you earn from the bond and how long you keep it. You can earn in two ways: regular interest income and profit from selling or redeeming the bond, which is called a capital gain. Let’s go through each type of bond to understand how the tax is calculated in simple terms.
1. Regular Bonds
Regular bonds pay you fixed interest every year. This interest is added to your total income and taxed according to your income tax slab. For instance, if you invest ₹10 lakh in a bond that pays 8% interest, you will earn ₹80,000 each year. If you are in the 20% slab, you will pay ₹16,000 as tax on that interest. If you sell the bond before it matures and make a profit, that profit is treated as a capital gain. For listed bonds held for at least 12 months, long-term capital gains are taxed at 12.5%. If the bond is unlisted, the profit is always considered short-term after 23 July 2024 and taxed at your regular slab rate.
2. Zero-Coupon Bonds
Zero-coupon bonds do not pay any interest during their life. Instead, they are sold at a lower price and redeemed later at their full value. The difference between the purchase price and the redemption value is your capital gain. For example, if you buy a zero-coupon bond for ₹8 lakh and receive ₹10 lakh when it matures, your gain of ₹2 lakh will be taxed as capital gain. If the bond is listed and you held it for more than 12 months, the tax rate is 12.5%. If it is unlisted, it is always treated as short-term and taxed at your slab rate.
3. Government or Tax-Free Bonds
Government and tax-free bonds are among the safest investment options. Interest from tax-free bonds is completely exempt from tax under Section 10(15)(iv)(h) of the Income Tax Act. However, if you sell these bonds before maturity and make a profit, that profit is taxed as capital gain. For listed bonds held for more than 12 months, the tax rate is 12.5%. For example, if you earn ₹40,000 interest from an NHAI bond, you do not pay any tax on it. But if you sell the bond and make a profit of ₹20,000 after one year, you will pay ₹2,500 as tax (12.5%).
4. Section 54EC Bonds
Section 54EC bonds are meant to save tax when you sell property. If you earn a capital gain from selling a house or land, you can invest that amount in NHAI, REC, or PFC 54EC bonds within six months to avoid paying tax on that gain. You can invest up to ₹50 lakh in a financial year, and the investment must be held for five years. The main capital gain you reinvest becomes tax-free, but the interest you earn from these bonds (around 5% per year) is taxable as per your income slab.
5. Corporate Bonds
Corporate bonds are issued by companies and generally offer higher interest rates than government bonds. The interest you earn is fully taxable as regular income. When you sell these bonds, the taxation depends on whether the bond is listed and how long you held it. If it is listed and held for at least 12 months, the gain is long-term and taxed at 12.5% without indexation. If it is unlisted, the gain is always short-term after 23 July 2024 and taxed at your slab rate. For example, if you buy a listed corporate bond for ₹2 lakh and sell it after 14 months for ₹2.5 lakh, your profit of ₹50,000 is long-term and taxed at 12.5%, which means you pay ₹6,250 as tax.
Short-Term vs Long-Term Capital Gains Rules
How long you keep your bond before selling it decides whether your profit is short-term or long-term. For listed bonds, if you hold them for more than 12 months, your profit becomes long-term and gets a lower tax rate of 12.5%. If you sell before 12 months, it’s short-term and taxed at your slab rate. For unlisted bonds, starting July 2024, all profits are treated as short-term and taxed at slab rates; the long-term benefit no longer applies.
Summary of Tax Rules for 2025
So, every bond has a different way of giving you returns and a different way of being taxed.For example, if you buy a listed bond for ₹1 lakh and sell it after 10 months for ₹1.2 lakh, the ₹20,000 gain is short-term and taxed as per your slab. If you sell the same bond after 15 months, the profit becomes long-term, and your tax will only be ₹2,500 (12.5% of ₹20,000). The longer you hold your bonds, the less tax you usually pay.
Earlier, investors used indexation for unlisted bonds to reduce tax by adjusting the purchase price for inflation. That benefit has now been removed, so holding listed bonds has become much more tax-friendly.
TDS on Bonds
When you receive interest from bonds, the issuer may deduct tax before paying you. This is called Tax Deducted at Source (TDS), and it is controlled by Section 193 of the Income Tax Act. TDS is deducted only when your annual interest from one issuer exceeds ₹5,000. The rate of TDS is 10% if you have given your PAN, and 20% if you haven’t. There is no TDS on tax-free bonds. For non-resident investors (NRIs), TDS is usually 20% under Section 115A or as per the Double Taxation Avoidance Agreement (DTAA) between India and their country.
The deducted TDS amount appears in your Form 26AS and in your Annual Information Statement (AIS). Before filing your income tax return, always check that these entries match your records so that you get full credit for the tax already paid.
Bond Washing Transactions under Section 94(1)
Some investors try to avoid paying tax by transferring their bonds to someone else just before the interest is due. This is called a bond washing transaction. The idea is to make the other person receive the interest and pay the tax on it. But the Income Tax Department considers this a form of tax avoidance. The law states that the person who actually owned the bond when the interest became due will still be taxed for that income.
For example, if Rajesh transfers his bonds to his friend two days before the interest is paid, hoping to avoid tax, the department will still treat the interest as Rajesh’s income and tax him for it. It is always safer to declare your actual interest income correctly instead of trying such methods.
Reporting Bond Income in Your ITR
When you file your income tax return, make sure you report your bond income under the correct sections. Interest income should be entered under the “Income from Other Sources” schedule, and capital gains should be entered under the “Capital Gains” schedule. Verify all the TDS amounts shown in your Form 26AS with your bond statements. Also, review your Annual Information Statement (AIS) for any mismatch or wrong entries. If you find any errors, you can correct them by submitting feedback in AIS.
Tax Planning Tips for Bond Investors
Smart tax planning can make your bond investments more profitable. Prefer tax-free or Section 54EC bonds to reduce your tax burden. If you invest in listed bonds, try to hold them for more than 12 months so that your profits qualify for long-term capital gains tax at 12.5%. If you face any losses from bond sales, set them off against other capital gains under Sections 70 and 71. Reinvest your matured bond amounts into other tax-efficient investments to keep earning while saving tax. Avoid frequent buying and selling, as this increases both your tax liability and your paperwork. And finally, always review your Form 26AS and AIS before filing your return to ensure your records are accurate.
FAQs
Q1. Is interest on bonds taxable in India?
Yes. The interest you earn from most bonds in India is taxable and must be added to your total income. It is taxed as per your income slab. For example, if you earn ₹60,000 interest from bonds and fall in the 20% slab, you’ll pay ₹12,000 as tax. However, interest from certain government-backed bonds such as NHAI, REC, or PFC tax-free bonds is exempt under Section 10(15)(iv)(h). Even though it’s exempt, you should still report it in your ITR under “Exempt Income” for transparency.
Q2. How are capital gains on bonds taxed?
When you sell a bond before it matures, any profit you make is treated as a capital gain. For listed bonds, if you sell within 12 months, it’s considered a short-term gain and taxed at your slab rate. If you sell after 12 months, it’s a long-term gain taxed at 12.5% without indexation. For unlisted bonds, from 23 July 2024, all gains are treated as short-term, regardless of how long you held them.
Example: You buy a listed bond for ₹1,00,000 and sell it after 15 months for ₹1,20,000. Your profit of ₹20,000 is a long-term gain taxed at 12.5%, so you’ll pay ₹2,500 as tax.
Q3. What is the TDS rate on bond interest?
TDS (Tax Deducted at Source) is deducted by the issuer when your annual interest from that issuer crosses ₹5,000. The rate is 10% if you’ve provided your PAN and 20% if you haven’t. For example, if you earn ₹10,000 interest from a corporate bond, ₹1,000 will be deducted as TDS, and you’ll receive ₹9,000. The deducted amount appears in Form 26AS and can be claimed as a tax credit when you file your ITR. No TDS is deducted on tax-free bonds.
Q4. Are government bonds taxable?
Yes. The interest you earn from government bonds is taxable under “Income from Other Sources.” However, if you sell a listed government bond after holding it for at least 12 months, your profit is a long-term gain taxed at 12.5%. For instance, if you earn ₹15,000 interest from government securities, you’ll pay tax as per your slab. If you sell it after one year and earn ₹5,000 profit, you’ll pay ₹625 tax (12.5% of ₹5,000).
Q5. Are Sovereign Gold Bonds tax-free?
Sovereign Gold Bonds (SGBs) give you two types of income ,interest and capital gain. The interest of 2.5% per year is taxable under “Other Sources.” But the capital gain you make when you redeem the bond after eight years is completely tax-free under Section 47(viic). If you sell it before eight years in the secondary market, normal capital gain rules apply: short-term if held under 12 months and long-term at 12.5% if held 12 months or more.
Q6. What are Section 54EC bonds?
Section 54EC bonds help you save tax on capital gains from selling property. If you sell land or a building and invest the capital gain in 54EC bonds issued by NHAI, REC, or PFC within six months, you don’t have to pay tax on that amount. You can invest up to ₹50 lakh in a financial year, and the investment must be held for five years. The capital gain you reinvest becomes tax-free, but the interest you earn (usually around 5% per year) is taxable as per your slab.
Q7. How are zero-coupon bonds taxed?
Zero-coupon bonds don’t pay regular interest. They are sold at a lower price and redeemed later at full value. The difference between the issue price and the redemption value is your capital gain. If the bond is listed and held for at least 12 months, the gain is long-term and taxed at 12.5%. If it’s unlisted, it’s always short-term (after July 2024) and taxed as per your slab.
Example: You buy a bond for ₹80,000 and receive ₹1,00,000 at maturity. The ₹20,000 profit will be taxed depending on how long you held it and whether it was listed.
Q8. What are market-linked bonds?
Market-linked bonds are tied to a benchmark like NIFTY or Sensex. Their returns depend on how that index performs. If the market goes up, your returns increase. If it goes down, your returns drop. These bonds don’t pay fixed interest; instead, your income is treated as capital gains when you sell or redeem them. If held for less than 12 months, the gain is short-term and taxed at your slab rate. If held for 12 months or more, it becomes long-term and taxed at 10 or 12.5%, depending on the bond structure.
Q9. What are bond washing transactions?
A bond washing transaction happens when someone transfers bonds to another person just before the interest payment date to avoid paying tax on the interest. For example, if you sell your bonds to your friend a few days before the interest date so that they receive the interest, the Income Tax Department still counts that interest as your income. Under Section 94(1), the department will add that interest back to your income and tax you for it. It’s always safer to declare your actual interest income correctly in your return.
Q10. Do I have to show tax-free interest in my ITR?
Yes, you should. Even if your interest is completely tax-free, it’s important to report it under the “Exempt Income” section in your ITR. Doing this keeps your return transparent and avoids mismatches with your AIS (Annual Information Statement). For example, if you earn ₹30,000 interest from tax-free bonds, you pay no tax, but you must still show it in your ITR.
Q11. Can NRIs invest in bonds and how are they taxed?
Yes, Non-Resident Indians (NRIs) can invest in both government and corporate bonds in India. The interest they earn is taxed at 20% under Section 115A, unless a lower rate applies under a Double Taxation Avoidance Agreement (DTAA). The capital gains are taxed the same way as for resident investors, short-term at slab rate and long-term at 12.5% for listed bonds held for more than 12 months. NRIs can also repatriate their investment proceeds, subject to RBI regulations.
Q12. What happens if I don’t report my bond income in the ITR?
If you forget or intentionally skip reporting bond income, the Income Tax Department may detect the mismatch through your AIS or Form 26AS, which records all your interest and TDS details.
You might receive a notice under Section 143(1) or 142(1) asking for clarification. It’s always best to report all interest and capital gains correctly, even if the tax is already deducted, to avoid penalties or re-assessment later.
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