Taxation of corporate bonds

When the investor invests in corporate bonds, either directly or through a mutual fund scheme, there are two taxable incidents/components to look out for.

One component is that the corporate bond has a coupon rate, that is, a fixed rate of interest is paid at regular intervals to the bondholder. For taxation purposes, this is added to the income of the bondholder and taxed as per the applicable slab. The other tax incidence is in the form of capital gains when the bond is sold or redeemed.

However, in the case of investing in corporate bonds through mutual funds, one needs to pay only capital gains tax on redemption. So in a way, the interest received by the bond is indexed if the holding period is more than three years. You don't have that advantage while investing in bonds directly.

The capital gains work the same way in both methods. If a holder holds the investment for more than three years, then he/she will pay 20 per cent tax after availing the indexation benefit. If the investment is held for less than three years, then the gains are added to the income of the investor, and the tax has to be paid according to the income tax slab.

The bonds pay an interest/coupon regularly until the bond matures. There is a difference in how this interest is taxed. If the investor buys the bonds directly, he/she will have to pay tax on every coupon received. It is added to income and taxed as per the investor's slab. If the investor bought debt funds that invested in corporate bonds, the interest is used to repurchase the units. This is termed as capital gain when sold.

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This article was originally published on June 09, 2022.