Income Tax Return: Know how bonds, debt funds and securities are taxed before filing your ITR

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With the 10-year Infrastructure Bonds – issued to help taxpayers to avail deductions up to Rs 20,000 by investing in such bonds – maturing, many taxpayers are confused if the maturity value is tax free or whether indexation benefit is available while calculating tax payable on these bonds.

As different debt instruments like Bonds, Debentures – including Non-Convertible Debenture (NCD), debt-oriented Mutual Fund (MF) schemes, debt securities etc have different taxation rules, it’s important to know they are taxed before filing your returns of income.

Dr. Suresh Surana, Founder, RSM India explains the tax rules to make the things simple for you:

What are the differences between the short-term and long-term holding periods for debt mutual funds and debt securities like Bonds, NCDs etc?

Taxation of Capital Gains under the Income Tax Act 1961 (“the IT Act”) depends on whether the asset classifies as a Long Term Capital Asset or a Short Term Capital Asset depending upon the period of holding of such asset. Section 2(42A) of the IT Act provides for period of holding as a basis to determine whether the debt instrument would be classified as a Short Term Capital Asset. However, the threshold period of holding for classification into short term and long term depends upon the nature of the debt instrument.

The below table summarises the holding period for different classes of assets:

Holding periods of different debt securities for determining short-term and long-term capital gains.

With reference to the above table, in case of Debt Securities like Bonds and NCDs which are listed on a Recognized Stock Exchange in India, the period of holding shall be 12 months whereas in case of debt mutual funds or unlisted debt securities the period of holding shall be 36 months. In other words, if the assets are held upto their respective holding periods then they will be categorised as Short-Term Capital Asset, and if they are held for more than their respective holding periods, then they would be classified as Long term capital asset.

How are short-term and long-term gains of debt MF and debt securities taxed? Where are the indexation benefits available and where not?

The tax implication of gains derived from Debt Mutual Funds and other Debt Securities are as follows:

Taxation of Long Term Capital Gains on transfer of Debt Securities/ Mutual Funds:

Section 112 of the IT Act governs taxation of long-term capital gains on transfer of Debt Mutual Funds. According to this section, long term capital gains derived from debt mutual funds held for a period of more than 36 months (3 years) would be subjected to tax of 20 per cent after availing the benefit of indexation. Thus, capital gains would be computed as the difference between the Sale Consideration (Net of Incidental Expenses such as brokerage, etc. other than STT) and the Indexed Cost of Acquisition.

Indexation refers to adjusting the purchase price in regards to the cost of inflation and Indexed Cost of Acquisition would be computed as follows:

Indexed cost of acquisition = Cost of Acquisition X Cost Inflation Index of the year of transfer / Cost Inflation Index of the year of acquisition

However, the above Cost of Acquisition for debt mutual funds acquired before 1st April 2001 would be the Original cost of acquisition or Fair Market Value on 1st April 2001, whichever is higher.

It is pertinent to note that indexation benefit is not available in case of Debt securities such as Debentures and Bonds except in case of Capital Indexed Bonds and Sovereign Gold Bond issued by the RBI.

In case of certain listed debt securities (other than units) and zero coupon bonds, the capital gains shall be taxable at the rate of 20 per cent (with indexation benefit, if available) or 10 per cent whichever is more beneficial to the assessee.

Taxation of Short-Term Capital Gains on transfer of Debt Securities / Debt Mutual Funds:

Short term Capital gains on the transfer of Debt securities held for upto 36 months would be subjected to tax as per the marginal slab rates applicable to the investor. However, in case of short term capital gains, no indexation benefit would be available to the investor taxpayer.

Is there any difference in taxation for listed and unlisted debt funds and debt securities?

The taxation of listed debt securities differs from taxation of unlisted securities in respect of period of holding and accordingly the applicable tax rates would be applied on such term capital gains as mentioned above.

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