Bond Taxation in India: The New Rules (FY 2025)

Updated post July 2024 Budget

If you are investing in bonds, what you earn is not what you keep. The Indian taxation landscape for debt instruments has undergone radical changes in the last two years—specifically via the Finance Act 2023 and the Union Budget (July) 2024.

The days of "Indexation Benefits" are largely over for mutual funds, but direct bonds have gained a slight edge. Here is everything you need to know.

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1. The Big Divide: Interest vs. Capital Gains

To understand taxation, you must separate your earnings into two buckets:

Interest Income (Coupon): This is the regular payout you get every year/half-year.
Capital Gains: This is the profit you make if you sell the bond (or fund) at a higher price than you bought it.

2. Taxation of Debt Mutual Funds

(Includes Target Maturity Funds, Liquid Funds, and Debt ETFs)

This is where the biggest change happened in April 2023. If a mutual fund invests less than 35% in domestic equity, it is classified as a Specified Mutual Fund.

            The Rule: All gains (Interest or Capital Gains) are added to your income and taxed at your Slab Rate.
        

It does not matter if you hold the fund for 10 days or 10 years. There is no concept of Long Term Capital Gains (LTCG) or Indexation benefits for fresh investments made after April 1, 2023.

3. Taxation of Listed Bonds (Direct)

(G-Secs, SDLs, and Listed Corporate Bonds bought via RBI Retail Direct or Demat)

Direct bonds now have a slight tax advantage over Debt Mutual Funds for high-net-worth individuals.

Type of Income	Holding Period	Tax Rate
Interest (Coupon)	Any	Slab Rate
Short Term Gains	< 12 Months	Slab Rate
Long Term Gains	> 12 Months	12.5% (No Indexation)

Update (July 2024 Budget): The holding period for bonds to be considered "Long Term" was reduced from 36 months to 12 months. The tax rate was set to 12.5% (without indexation). This is beneficial if you trade bonds in the secondary market.

4. Tax-Free Bonds & SGBs

These remain the holy grail for tax efficiency, though supply is limited.

A. Tax-Free PSU Bonds

Issued by REC, PFC, NHAI, etc. The interest income is 100% Tax-Free (under Section 10). However, if you sell them on the exchange for a profit, Capital Gains tax applies (12.5% LTCG if > 12 months).

B. Sovereign Gold Bonds (SGBs)

Interest (2.5%): Taxed at Slab Rate.
Redemption (Maturity): 100% Tax-Free. No Capital Gains tax.
Secondary Sale: If sold on exchange before maturity, LTCG rules apply (12.5%).

Summary: Where should you invest?

If you are in the 30% Tax Bracket, here is the hierarchy of efficiency:

Tax-Free Bonds / SGBs: Highest efficiency (but liquidity is low).
Direct G-Secs/Bonds: If you plan to sell before maturity for a profit (12.5% tax vs 30%).
Debt Mutual Funds: Least tax-efficient (30% tax), but offer the highest liquidity and ease of management.

*Disclaimer: Tax laws in India change frequently. This information is based on the Finance Act (No. 2) 2024. Please consult a Chartered Accountant (CA) before filing your taxes.