By Joydeep Sen
The salient side of taxation of bonds is that the coupon or curiosity on bonds / debentures is taxable as ‘other income’, which is taxable at your marginal slab price. For most traders, the marginal slab price is 30% plus surcharge and cess. Only a number of traders could be at a decrease tax bracket; as an illustration, senior residents. In different phrases, there isn’t any approach to optimise the coupon / curiosity on bonds from a taxation perspective.
The capital positive factors tax element is taxable at a comparatively decrease price, offered you maintain it for the requisite interval. For listed bonds, the holding interval required for taxation as long-term capital positive factors is one yr. If you maintain a listed bond for lower than one yr, it’s taxable at your marginal slab price. The good half is, for a holding interval of a couple of yr, the speed is 10% plus surcharge and cess. However, from a broad perspective, this per se doesn’t result in a lot tax effectivity. The purpose is, a lot of the returns from bonds come from the coupon / curiosity and solely a small element comes from capital positive factors, that too for those who promote earlier than maturity at a revenue in comparison with your buy worth.
Illustration
You buy a bond within the main market on the face worth of Rs 100, and the bond is listed. The bond carries a coupon of seven%. You maintain it for 3 years and promote it for Rs 102. In this case, your complete return over three years is Rs 7 per yr of coupon = Rs 21 plus Rs 2 of capital positive factors = Rs 23. Of this, Rs 21 is from coupon which is taxable at your marginal slab price. Only Rs 2 is capital positive factors taxable at 10%. If you maintain it until maturity, or if the sale worth is lower than Rs 100, there gained’t be any capital achieve and your entire incomes could be from coupon solely.
Nuances
For readability, in zero-coupon bonds, the distinction between situation worth and maturity worth is taxable at your marginal slab price. Though technically there isn’t any coupon as such in a zero-coupon bond, conceptually, it’s akin to coupon, and taxable on the identical price. The solely exception to that is sure notified zero-coupon bonds, that are taxable as capital positive factors, notified beneath Section 2(48) of Income Tax Act.
In Section 54EC capital positive factors tax financial savings bonds, when you save as much as Rs 50 lakh of capital positive factors tax per monetary yr, the coupon on these bonds is taxable at your slab price.
Indexation for computation of long-term capital positive factors tax is offered in debt mutual funds over a holding interval of three years or extra. This generates important tax effectivity. However, that is accessible solely in mutual funds, not in direct holding of bonds. The non-availability of indexation for taxation in bonds limits the avenues for producing tax effectivity.
Tax-efficient choice
There are tax-free bonds issued by sure public sector undertakings (PSUs). There have been no contemporary issuances over the past six years, however the present inventory is offered via the secondary market. The coupon on these is tax-free; in case of any capital achieve, that element could be taxable. These are rated AAA, therefore prime credit score high quality. The yield (annualized rate of interest) accessible within the secondary market in tax-free PSU bonds could be consequently decrease, because the market components within the tax effectivity whereas dealing in these.
The manner to take a look at these is the comparable pre-tax equal yield degree. As an instance, in case you are getting a tax-free PSU bond at a yield of say 5.25% and your tax price is 31.2% together with cess, then the comparable degree is 5.25% / (1-31.2%) = 5.25% / 0.688 = 7.63%. The assumption right here is, for those who put money into an standard taxable bond, it’s a must to pay tax at 31.2%, therefore the matching degree of yield is 7.63% to get 5.25% web of tax. You must verify whether or not you might be getting that degree of return in comparable high quality AAA rated taxable PSU bonds from the secondary market.
Conclusion
Mutual funds are extra tax environment friendly over a holding interval of three years, by advantage of indexation. Direct bonds are tax-efficient for folks in comparatively decrease tax bracket.
(The author is a company coach and an writer.)
Source: www.financialexpress.com”