Zero Coupon Bonds: Know tax rules when such a bond is held till maturity, sold early | The Financial Express

Zero Coupon Bonds: Know tax rules when such a bond is held till maturity, sold early

As the coupon rate of a zero coupon bond is zero per cent, people investing in such bonds don’t get regular interest, but get a deep discount on face value at the time of issuance of such a bond.

Zero Coupon Bonds: Know tax rules when such a bond is held till maturity, sold early
The tax rules change, depending on the holding period, amount of gains or loss.

In bond terms, coupon rate means the rate of interest offered on a bond. As the coupon rate of a zero coupon bond is zero per cent, people investing in such bonds don’t get regular interest, but get a deep discount on face value at the time of issuance of such a bond. At the time of maturity, the investor gets the bond redeemed at the face value. So, the discount amount is the gain for the investor over the investment period.

However, instead of holding the bond till maturity, an investor may sell it off in the secondary market to exit early. So, an investor also has the option to buy zero coupon bonds from the secondary markets and/or sell it as well. But, along with providing liquidity, the secondary market will pose market risks to the bond holders, where they may make additional gains or even suffer losses.

The tax rule will change, depending on the holding period, amount of gains or loss.

Dr. Suresh Surana, Founder, RSM India describes the tax implications on zero coupon bonds:

When a zero coupon bond is bought from primary market and held till maturity

Zero coupon bonds by its name clarifies that these are bonds which do not pay any interest/coupon during its tenure. Thus, all the income in the form of capital appreciation would arise only at the time of redemption or transfer of the said bond.

As per the provisions of section 2(14) of the IT Act, zero coupon bonds also known as deep discount bonds are covered under the definition of capital assets. Thus, transfer of the same before or at the time of maturity would be taxed under the head Capital Gains. Further, as per the provisions of section 2(42A) of the IT Act, if a zero coupon bond is held for a period up to 12 months then the same will be treated as short term capital asset and the gains arising from transfer of the same will be taxed as short term capital gains. On the other hand, if the bond is held for a period exceeding 12 months then it will be classified as long term capital asset and gains on such bond will be taxed as long term capital gains.

Short term capital gains on transfer of such bonds will be taxable at the applicable marginal rates of tax for an assessee. However, long term capital gains will be taxed in accordance with the provisions of section 112 of the IT Act which states the rate of tax to be 20 per cent (after claiming the benefit of indexation). However, the said section gives an option to forego the benefit of indexation and charge such LTCG at 10 per cent.

When a zero coupon bond is bought from primary market and sold in secondary market through recognized stock exchange

Unlike Taxation of Bonds, the Taxation of zero coupon bonds does not undergo any change depending upon the nature of the bond i.e. listed or unlisted. Thus, taxation of zero coupon bond merely depends upon the period of holding.

When a zero coupon bond is sold in the secondary market which was originally purchased from the primary market, the same will be taxed akin to the scenario when a zero coupon bond is bought from the primary market and held till maturity. LTCG will be taxed at 20 per cent (with indexation) /10 per cent (without indexation) and STCG will be taxed at applicable slab rates.

When a zero coupon bond is bought from secondary market through recognized stock exchange and sold in off market

When a zero coupon bond is sold in Off market which was originally purchased from secondary market, the same will be taxed akin to the scenario when a zero coupon bond is bought from primary market and held till maturity. LTCG will be taxed at 20 per cent (with indexation)/ 10 per cent (without indexation) and STCG will be taxed at applicable slab rates.

In the following cases the same tax rules will apply as applicable to the scenario when a zero coupon bond is bought from the primary market and held till maturity –

  • When a zero coupon bond is bought from the primary market and sold in the off market.
  • When a zero coupon bond is bought from off market and sold in off market.
  • When a zero coupon bond is bought from off market and held till maturity.

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