Bonds are generally interest bearing instruments with some exceptions like zero coupon bond, where no interest is given, but bonds are issued at a discounted price and redeemed at the face value.
However, unlike fixed deposits (FDs), investors generally get the options to buy and/or sell the bonds in the secondary markets, which provide them additional liquidity.
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Along with liquidity, the secondary markets come with their own risks, where an investor may gain or lose depending on demand for a particular bond and other factors affecting a debt market.
Apart from the zero coupon bond, there are several other types of bonds – like Convertible Bonds/Debentures, Non-convertible Bonds/Debentures, Sovereign Gold Bond (SGB), Infrastructure Bonds, Capital Gain Bonds, Tax-free Bonds, Capital Indexation Bonds etc.
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For the bonds bought from the issuing authorities and held till maturity, the taxation would be the same as that of a FD, unless it’s a special bond – like a Tax-free Bond, SGB, Capital Indexation Bond, Zero Coupon Bond, etc.
However, the taxation becomes different when bonds are traded in the secondary markets. As there is a scope of earning extra gains by buying and selling bonds in the secondary markets, which attracts capital gain tax as well.
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Tax rules also change, in case a bond is converted into shares.
Dr. Suresh Surana, Founder, RSM India describes the tax implications in the case of conversion of a bond:
When a convertible bond is converted in shares
In accordance with sec 47(x) of the IT Act, any transfer by way of conversion of bonds or debentures, debenture-stock or deposit certificates in any form, of a company into shares or debentures of that company would not be regarded as transfer for the purpose of capital gain computation. Hence the said conversion of bonds into shares does not attract any capital gains tax implications at the point of conversion.
However, when such shares are sold off, capital gains tax would be applicable and for the purpose of computing capital gains from such shares, the acquisition cost as well as the period of holding of the debenture would be relevant.
