How are government bonds taxed?

Indian investors are spoilt for choice when it comes to investing. From mutual funds, stocks to corporate deposits, the range is vast. Now the Reserve Bank of India (RBI) has added one more option of buying government bonds directly by opening gilt accounts with the central bank. This opens a new avenue for conservative investors for whom preservation of capital is of utmost importance. The current yield on the 10-year government bond is 6.126%. 

Experts say retail participation is going to increase with direct buying and selling of G-secs. “The notification issued by the RBI explicitly specifies that retail investors will get access to select government securities via a ‘Retail Direct Gilt Account’ (RDG Account). Under the RBI Retail Direct scheme, the government securities such as treasury bills, dated securities, sovereign gold bonds (SGB), and state development loans (SDLs) will be accessible,” said Rachit Chawla, CEO and founder, Finway FSC.

But before you plan to invest in these bonds, it is equally important to understand their tax implications. Here is the primer:

Taxability of government bonds

Primary market purchase: If a bond is held until maturity, the interest income is taxed according to the respective tax slab and there is no capital gain tax. “There are two elements of bonds that are considered at the time of sale or maturity from a taxation perspective. One is the interest earned and the second is the capital gain on the bond at the time of sale. When the bonds are held until maturity, they get back their face value; hence, that investment does not attract any capital gain. However, the interest earned will be taxed,” said Harshad Chetanwala, co-founder, MyWeathGrowth.

Secondary market purchase: If the bond is traded in the secondary market before reaching maturity, then apart from tax on interest income, the seller will be liable to pay capital gains tax according to the holding period. “The bonds that are sold in the secondary market before their maturity will be taxed like any other debt investment. “Short-term capital gains will be applicable up to three years of investment; these short-term gains will be taxed as per the income tax slab of the investor. If these bonds are held for more than three years, investors are liable to pay long-term capital gains tax at 20% with indexation benefit,” said Chetanwala.

Sovereign Gold Bonds (SGBs): No tax is levied on the redemption of SGB after completion of the maturity period. If, however, sold before three years, then the gains get taxable as short-term capital gains and taxed as per income tax slab. For gold held more than three years, the profit is categorised as long-term capital gains. LTCG is taxed at 20% post indexation along with applicable surcharge and cess.

The tax treatment for all bonds except tax-free will be the same.