How does income from bonds, deposits and debt funds get taxed?

With the rise in interest rates, debt instruments such as bonds, deposits and debt funds have become attractive to park your money. But before investing in fixed-income products one needs to be mindful of the interest rate cycle and maturity of the securities as the interest rate and bond prices are inversely co-related. However, there is one more element that one needs to be mindful of. It is how they are taxed, as each debt instrument is taxed differently making post-tax return differ from product to product. Here is a lowdown on how bonds, deposits and debt funds are taxed to help you choose the right product :

Bonds: There are two elements of bonds that are considered from a taxation perspective: interest earned and capital gain at the time of sale. When the bonds are held till maturity, the investment does not attract any capital gain as one gets back the face value. However, the interest earned gets taxed at an individual’s tax slab rate.

The bonds that are sold in the secondary market before their maturity have to pay tax on the capital gain. Short-term capital gains will be applicable for up to one year of investment as per the income tax slab of the investor. If these bonds are held for more than one year, a long-term capital gain tax of 10 per cent with no indexation benefit is levied.

Similarly, listed corporate bonds are taxable at 10 per cent with no indexation benefit for a holding period over 12 months. They are taxable as per the tax slab if the holding period is below 12 months. Unlisted bonds are taxable at 20% with no indexation benefit if the holding period is more than 36 months. For less than 36 months it is taxed as per the individual’s slab.

Debt Funds: One of the biggest reasons for investing in debt funds is the tax advantage they offer. If an investor would to hold an investment in mutual funds for more than 3 years, the investor would need to pay tax at long-term capital gains tax at 20 per cent with indexation benefit. Hence, the post-tax returns for debt mutual funds could be far higher than the post-tax returns of bank FDs as there are no tax benefits for holding 3-year deposits. The return is taxed as per individual tax slab if redeemed before 3 years.

Deposits: In the case of deposits the money gets locked for a certain term. Here the tax is paid on interest income based on individual tax slab rates. The bank will also deduct tax at source at the rate of 10 per cent on the interest payable if the interest is above Rs. 40,000 per annum and Rs. 50,000 per annum in the case of senior citizens.

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