Income tax on income from government bonds is leviable in two ways. One, you will be taxed if you earn capital gains on selling the government bonds before the maturity date in the secondary market. Two, the interest you earn on these bonds will also be taxed.
Income tax on capital gains accrued from government bonds
The selling of government bonds in the secondary market can lead to either capital losses or gains. If you sell the bonds at a price higher than what you bought it for (primary or secondary market), then you will earn capital gains. On the other hand, if the price at which the bonds are sold is less than the price at which they were bought, then you will incur capital losses.
S Vasudevan, Executive Partner, Lakshmikumaran & Sridharan Attorneys says, “Capital gains/losses are classified as short-term and long-term on the basis of the holding period of the asset. If the government bonds (listed on recognized exchange) are sold after holding them for period of more than 12 months, then gains/losses will be classified as long term. On the other hand, if the period is less than or equal to 12 months, then gains/losses are classified as short term.”
The tax rate applicable on these short-term and long-term capital gains are different. “Short term capital gains accrued on government bonds are taxed at normal rates applicable on the income of an individual. On the other hand, long-term capital gains from listed government bonds are taxed at the rate of 10% (without indexation benefit),” says Vasudevan.
Here individuals need to keep in mind that taxation rules of listed government bonds and debt mutual funds are different. The rules of debt mutual funds taxation were amended with effect from April 1, 2015. “The government with effect from FY 2014-15 has amended the provisions relating to taxation of debt mutual funds. Till FY 2013-14, long term gains on debt mutual funds could be taxed at either 20% (with indexation) or 10% (without indexation) at the choice of individual. However, the government removed the option of using of 10% (without indexation) for units (including units of debt mutual funds),” says Vasudevan.
Debt mutual funds include mutual fund schemes investing in debt securities including those that invest only in government securities and gilt. Such mutual fund schemes are commonly called gilt mutual fund schemes. Consequently, the taxation of long-term capital gains incurred on units of gilts mutual funds and those incurred on gilts bought directly is different.
Taxation of listed government bonds vs debt mutual funds
|Listed Debt Mutual Fund||Listed Government bonds|
|Period of holding to classify as long term||36 months||12 months|
|Income tax rate for long term capital gains||20% (with indexation)||10% (without indexation)|
With regards to government bonds, in case of losses, an individual is allowed to set-off short-term losses from government bonds against other long-term or short-term capital gains from other securities such as shares, mutual funds etc., as per income tax laws. However, do keep in mind that long-term capital losses from government bonds can only be adjusted against long-term capital gains from other securities such as shares, mutual funds etc.
Income tax on interest earned from government bonds
Interest received from government bonds is taxed like bank fixed deposits’ interest income. That is, the interest received by you will be taxed at the income tax rate applicable to your income, depending on the tax regime you have opted for. Further, as per section 193 of the Income-tax Act, interest payable on any security (including government bonds) of Central Government or State Government is not subject to TDS.