NISM-Series-X-B: Investment Adviser (Level 2) · Taxation of Debt Products

Taxation of Zero Coupon Bonds, Deep Discount Bonds and T-Bills

Updated 11 October 2026 · Fact-checked

Discount instruments pay no regular coupon. You buy below face value and receive face value later. Held to maturity, the discount is generally taxed as interest income at slab rate. Sold before maturity, the part of the price that is accrued discount may be taxed as interest. The remainder is a capital gain, taxed by holding period and listing status.

Understand Taxation of Zero Coupon Bonds, Deep Discount Bonds and T-Bills

A discount instrument pays no periodic coupon. You buy it at a price below its face value. At maturity you receive the face value. The difference is your return. Treasury bills, zero coupon bonds and deep discount bonds all work this way.

A treasury bill (T-bill) is a short-term government security, issued for 91, 182 or 364 days. A zero coupon bond pays nothing until maturity. A deep discount bond is issued at a large discount and usually has a long tenure. A strip is a coupon or principal cash flow separated from a bond and traded on its own. It behaves like a zero coupon instrument.

The tax question is: what kind of income is the discount? There are two possible heads. If you hold to maturity, the discount is the reward for lending money. It is treated as interest, under Income from Other Sources, and taxed at your slab rate. If you sell before maturity, the simple rule is that the difference between sale price and purchase price is a capital gain. Its rate depends on how long you held it and whether the bond is listed.

This simple rule is a simplification. The discount builds up over the holding period. If you sell between interest dates or before maturity, part of the sale price may represent accrued discount or accrued interest. That part may be taxed as interest. The capital gain is only the remainder. Exam questions usually say how to treat the gain. If a question states that the whole gain is a capital gain, follow it. The separate page on bond stripping and accrued interest covers the accrued portion.

The interest part also raises a timing question. The discount builds up over the life of the bond. Under the accrual (mercantile) method, it is taxed year by year as it accrues. Under the cash method, it is taxed when received. The method depends on the assessee's regular method of accounting. Do not assume one method without reading the question.

For listed securities, including listed bonds and debentures, the holding period test is 12 months. Held for more than 12 months, the gain is long-term. For transfers on or after 23 July 2024, long-term gains on listed securities are taxed at 12.5% without indexation (Sec 112). The exceptions are equity shares and units covered by Sec 112A, which have their own rules. Held for 12 months or less, the gain on a listed security is short-term and taxed at slab rate.

A T-bill has a maximum life of 364 days. Held for at most 364 days, it cannot satisfy any long-term holding period test. So any capital gain on a T-bill is short-term and taxed at slab rate, apart from any accrued-interest portion, which is taxed as interest.

Sec 50AA deems some gains short-term, whatever the holding period. Market-linked debentures have been covered by Sec 50AA since 1 April 2023. Unlisted bonds and debentures were added for transfers, redemptions or maturities on or after 23 July 2024. Gains on these are deemed short-term and taxed at slab rate. Special rules also apply to notified zero coupon bonds and to strips. Learn the rule as your NISM workbook states it, and check the latest rates before the exam.

Key formulas to remember

Discount (return): Discount = Face value − Purchase price; This is the total return if you hold to maturity.
Held to maturity: Taxable = Discount → Income from Other Sources (interest), taxed at slab rate; Timing depends on the accounting method: accrual or cash.
Sold before maturity: Capital gain = Sale price − Cost of acquisition (− transfer expenses); Simplified rule. Any part of the price that is accrued discount or interest may be taxed as interest, and the capital gain is the remainder. Short-term or long-term depends on holding period and listing.
Tax with cess: Tax = Income × slab rate × 1.04; Health and education cess is 4% of tax. Surcharge may apply at high incomes.
Holding period for listed securities: Long-term if held for more than 12 months; long-term gain taxed at 12.5% without indexation (Sec 112, transfers on or after 23 July 2024); Applies to listed securities other than equity shares and units covered by Sec 112A. Listed and held 12 months or less: short-term, slab rate. Sec 50AA: market-linked debentures have been deemed short-term since 1 April 2023, and unlisted bonds and debentures are deemed short-term for transfers on or after 23 July 2024. Both are taxed at slab rate, whatever the holding period. A T-bill is held for at most 364 days, so any capital gain on it is short-term.

How to solve Taxation of Zero Coupon Bonds, Deep Discount Bonds and T-Bills questions

Use this order for any question on discount instruments. Decide the head of income first. Then compute the number.

1Identify the instrument: T-bill, zero coupon bond, deep discount bond or strip.
2Check what the investor did: held to maturity or sold before maturity.
3If held to maturity, treat the discount (face value − cost) as interest income under Income from Other Sources.
4Check the accounting method. Accrual means tax is spread over the years. Cash means tax falls in the year of receipt.
5If sold earlier, compute capital gain as sale price − cost of acquisition, unless the question says part of the price is accrued interest. That part is taxed as interest and the capital gain is the remainder. Then test holding period and listing status to decide short-term or long-term.
6Apply the right rate: slab rate for interest and short-term gains, the special rate for eligible long-term gains.
7Add 4% cess to the tax. Then check the options for a trap such as 'tax-free' or 'exempt'.

Quickest way: Held or sold? Two-question shortcut

When to use it: Use this for one-line MCQs that ask how the gain or discount is taxed. It is a simplified rule.

Ask: did the investor hold to maturity? If yes, answer interest at slab rate.
If sold before maturity, answer capital gain. Remember that any accrued discount or interest in the price may be taxed as interest, and only the remainder is capital gain.
For the capital gain, ask: is it a market-linked debenture, or an unlisted bond or debenture transferred on or after 23 July 2024? If yes, deemed short-term (Sec 50AA) at slab rate.
If listed, count the months. 12 months or less is short-term at slab rate. More than 12 months is long-term, taxed at 12.5% without indexation (Sec 112). A T-bill is always held 364 days or less, so its gain is short-term.
Pick the option that matches. Reject any option that calls the discount tax-free.

Common mistakes in Taxation of Zero Coupon Bonds, Deep Discount Bonds and T-Bills

Treating the discount as a capital gain even when the bond is held to maturity.
The investor never receives interest, so it feels like a price gain.
Fix: Held to maturity means the discount is interest income. Capital gain arises only on sale or transfer before maturity.
Assuming zero coupon bonds have no tax until redemption in every case.
No cash comes in each year, so students think nothing is taxable.
Fix: Under the accrual method, the discount is taxed as it builds up. Check the assessee's method of accounting.
Applying the long-term rate to an unlisted bond held for years.
Students apply the general holding-period rule to all securities.
Fix: From 23 July 2024, gains on transfer of unlisted bonds and debentures are deemed short-term (Sec 50AA) and taxed at slab rate, whatever the holding period. Only listed bonds held more than 12 months get long-term treatment.
Forgetting the 4% cess and computing tax only at the slab rate.
The slab rate is memorised, but cess is treated as an afterthought.
Fix: Add 4% of the tax as cess. Surcharge may also apply at high incomes if the question says so.
Using face value instead of purchase price when computing the gain on early sale.
The face value is the number the question highlights.
Fix: Capital gain is sale price − cost. Face value matters only at maturity.

Worked examples

Example 1

Meera, an individual in the 30% slab, buys a 91-day T-bill with face value ₹1,00,000 for ₹98,000 and holds it to maturity. How much tax is payable on the return? Assume cess of 4% and no surcharge.

Show the solution

Discount = ₹1,00,000 − ₹98,000 = ₹2,000.
She held to maturity, so the discount is interest income under Income from Other Sources.
Tax at slab rate = 30% × ₹2,000 = ₹600.
Cess = 4% × ₹600 = ₹24.
Total tax = ₹600 + ₹24 = ₹624.

Answer: ₹624 (interest income taxed at slab rate).

Example 2

Ravi, an individual in the 20% slab, buys a listed zero coupon bond of face value ₹1,00,000 in the secondary market for ₹97,000 and sells it on the exchange after 40 days for ₹98,500, before maturity. Assume the entire gain is treated as a capital gain (no part is taxed as accrued interest). What is his capital gain and the tax on it? Assume cess of 4%, no surcharge and no transfer expenses.

Show the solution

He sold before maturity, and the question tells us to treat the whole gain as a capital gain. In practice, a part could be accrued discount taxed as interest, but we assume none here.
Capital gain = ₹98,500 − ₹97,000 = ₹1,500.
The bond is listed and the holding period is 40 days, which is 12 months or less, so the gain is short-term.
Short-term gain here is taxed at slab rate: 20% × ₹1,500 = ₹300.
Cess = 4% × ₹300 = ₹12.
Total tax = ₹300 + ₹12 = ₹312.

Answer: Short-term capital gain of ₹1,500 (on the stated assumption); tax ₹312.

Exam tips

The first thing to check in any question is 'held to maturity' or 'sold before maturity'. It decides interest versus capital gain.
Watch for the word 'unlisted'. It changes long-term treatment to short-term at slab rate.
Options that call the discount 'exempt' or 'tax-free' are usually traps unless the instrument is specifically tax-free.
Read the numbers carefully. Capital gain uses purchase price, interest uses face value minus purchase price.
With negative marking, skip a question only if you cannot decide between interest and capital gain. Most questions turn on that one point.

Practice questions from Taxation of Debt Products

Taxation of Zero Coupon Bonds, Deep Discount Bonds and T-Bills in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Actuarial Core Principles (IAI)Spot Rates and Zero-Coupon Bond Pricing

Taxation of Zero Coupon Bonds, Deep Discount Bonds and T-Bills: frequently asked questions

How is a zero coupon bond taxed in India?

If you hold it to maturity, the discount is generally taxed as interest income at your slab rate. If you sell before maturity, the gain is generally a capital gain, but any part that is accrued discount or interest may be taxed as interest. The exact treatment depends on the instrument, its listing status and your accounting method.

Is the discount on a T-bill interest or capital gain?

It depends on what you do. Held to maturity, the discount is treated as interest. Sold before maturity, the gain over your purchase price is generally a capital gain, apart from any accrued-interest portion. A T-bill lives at most 364 days, so such a gain is short-term.

Is tax charged every year on a deep discount bond or only at maturity?

It depends on the method of accounting. Under the accrual method, the discount is taxed as it accrues each year. Under the cash method, it is taxed when received.

What is the difference between interest and capital gain on discount bonds?

Interest is the discount earned by holding to maturity and is taxed at slab rate. A capital gain generally arises when you transfer the bond before maturity, after leaving out any accrued discount or interest taxed as interest. Its rate depends on the holding period and whether the bond is listed.