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

Taxation of Bonds and Debentures in India

Updated 11 October 2026 · Fact-checked

Interest on bonds and debentures is taxed as income from other sources at your slab rate. Sale gains are capital gains. Listed bonds held more than 12 months give long-term gains at 12.5% without indexation. Unlisted bonds and debentures are taxed as short-term gains at slab rate. Tax-free bond interest is exempt, but its sale gains are not.

Understand Taxation of Bonds and Debentures

A bond or debenture gives you two kinds of return: interest (the coupon) and a gain or loss on sale (the difference between sale price and cost). The tax law treats these separately. Never mix them.

Interest is generally taxed for an individual under income from other sources (interest on securities) at your normal slab rate. It is taxed whether the issuer is a company or the government. TDS may be cut when the issuer pays you. Interest on listed debentures held in demat form generally has no TDS, while interest on unlisted or physical debentures can attract TDS for a resident. TDS is only an advance payment. Your final tax is decided by your slab.

The gain on sale is a capital gain. For a listed bond, held for more than 12 months is long-term. Long-term gains are taxed at 12.5% without indexation. Held 12 months or less, the gain is short-term and taxed at slab rate. For unlisted bonds and debentures (and market linked debentures), the law treats the gain as short-term regardless of holding period, taxed at slab rate. Indexation is not available for bonds. The ₹1,25,000 long-term exemption applies only to listed equity-type gains, not to bonds.

Tax-free bonds are issued by specified government-backed entities. Their interest is exempt from tax in your hands, though you should still disclose it in your return as exempt income. If you sell them on the exchange at a profit, that gain is taxable like any listed bond: long-term after 12 months at 12.5%, otherwise at slab rate.

Accrued interest arises when you trade between coupon dates. The buyer pays the seller the interest earned so far, on top of the clean price. That portion is interest, not capital. The seller treats it as interest income. The buyer can reduce it from the next coupon received. Only the clean price is used to compute capital gain.

Key formulas to remember

Interest on bonds and debentures: Taxed at slab rate under income from other sources; Applies to corporate bonds, debentures and government securities. TDS is only an advance credit.
Long-term holding period, listed bonds: Held for more than 12 months; Exactly 12 months is still short-term. Long-term needs more than 12 months.
LTCG on listed bonds: Tax = 12.5% × (Sale price − Cost of acquisition − Transfer expenses); No indexation. No ₹1,25,000 exemption. Surcharge and cess are extra.
STCG on listed bonds: Tax = Slab rate × Gain; Applies when held for 12 months or less.
Unlisted bonds and debentures: Gain treated as short-term, taxed at slab rate, whatever the holding period; Rule applies to transfers on or after 23 July 2024. Learn it as a trap against the 24-month idea.
Tax-free bonds: Interest: exempt. Capital gain on sale: taxable; Exempt interest is still reported in the return.
Capital gain with accrued interest: Capital gain = Clean sale price − Cost (clean price paid); Accrued interest is taxed as interest; Do not include accrued interest in cost or sale value for capital gains.

How to solve Taxation of Bonds and Debentures questions

Use this order for any question on bond or debenture tax. It stops you mixing interest with capital gains.

1Identify the instrument: corporate bond, debenture, government security, or tax-free bond.
2Check if it is listed or unlisted. This decides the capital gains rule.
3Separate the cash flows: coupon interest, accrued interest at purchase or sale, and the sale gain.
4Tax the interest at slab rate, unless the bond is tax-free, in which case it is exempt.
5For the sale, compute the holding period. Listed: more than 12 months is long-term. Unlisted: always short-term.
6Compute the gain using clean prices and allowed transfer expenses. Do not index.
7Apply the rate: 12.5% for long-term listed, slab rate for short-term. Then adjust for TDS credit only if asked.

Quickest way: Three-question filter

When to use it: Use when the question is a one-line MCQ and you have under a minute.

Ask: is it interest or sale gain? Interest means slab rate, unless tax-free.
Ask: is it listed? Unlisted means short-term at slab rate. Listed means check more than 12 months.
Ask: is it tax-free bond? Interest exempt, gain taxable. Then pick the option that matches, and reject any option using indexation or a 24-month period.

Common mistakes in Taxation of Bonds and Debentures

Giving unlisted debentures a long-term gain after a long holding period.
Students carry over the general rule for unlisted assets.
Fix: Remember that unlisted bonds and debentures are treated as short-term whatever the holding period, taxed at slab rate.
Applying indexation to bond gains.
Older material allowed indexation for some debt gains.
Fix: For bonds and debentures, long-term gain is 12.5% without indexation. Reject any option that uses the Cost Inflation Index.
Saying that tax-free bonds are fully tax-free including sale gains.
The name suggests total exemption.
Fix: Only the interest is exempt. Gain on sale is taxable as capital gain.
Treating exactly 12 months as long-term.
Students read 'twelve months' as 'at least twelve'.
Fix: Listed securities need more than 12 months. Exactly 12 months is short-term.
Including accrued interest in the sale price for capital gains.
The buyer's total payment looks like one price.
Fix: Split it. Clean price goes to capital gain, accrued interest goes to interest income.
Assuming TDS equals the final tax.
Seeing tax deducted feels like the matter is closed.
Fix: TDS is an advance credit. Final tax is at slab rate, and the credit is adjusted against it.

Worked examples

Example 1

A resident individual buys a listed bond at a clean price of ₹1,00,000 and sells it 14 months later at a clean price of ₹1,10,000. Transfer expenses are nil. Compute tax on the gain, ignoring surcharge and cess.

Show the solution

The bond is listed and the holding period of 14 months is more than 12 months, so the gain is long-term.
Gain = ₹1,10,000 − ₹1,00,000 = ₹10,000.
No indexation is allowed and the ₹1,25,000 exemption does not apply to bonds.
Tax = 12.5% × ₹10,000 = ₹1,250.

Answer: Long-term capital gain of ₹10,000, taxed at 12.5%, so tax is ₹1,250 before surcharge and cess.

Example 2

An investor in the 30% slab bought an unlisted debenture for ₹2,00,000 and sold it in August 2024 for ₹2,30,000 after 3 years. The debenture paid regular coupons that she has already reported. Compute tax on the sale gain, ignoring cess.

Show the solution

The debenture is unlisted, so the gain is treated as short-term whatever the 3-year holding period.
Gain = ₹2,30,000 − ₹2,00,000 = ₹30,000.
Short-term gain is taxed at slab rate, here 30%.
Tax = 30% × ₹30,000 = ₹9,000.
The coupons are separate interest income already taxed at slab rate.

Answer: Short-term capital gain of ₹30,000, taxed at 30%, so tax is ₹9,000 before cess.

Exam tips

Always decide listed or unlisted first. Many options differ only on this point.
Eliminate options that mention indexation for bonds. Eliminate those that call tax-free bond sale gains exempt.
Watch for 'more than 12 months'. A holding of exactly 12 months is a favourite trap.
In accrued interest questions, split the payment into clean price and interest before computing anything.
On a 2-mark question a wrong answer costs more, so skip only if you cannot rule out two options.

Practice questions from Taxation of Other Products

Taxation of Bonds and Debentures in other exams

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

Taxation of Bonds and Debentures: frequently asked questions

How is interest on debentures taxed in India?

For an individual, interest on debentures is taxed at the slab rate under income from other sources. TDS may be deducted on certain debentures, such as unlisted or physical ones. You get credit for the TDS against your final tax.

What is the holding period for long-term capital gains on bonds?

For listed bonds, it must be more than 12 months. Unlisted bonds and debentures are treated as short-term whatever the holding period. Long-term gains on listed bonds are taxed at 12.5% without indexation.

Is interest on tax-free bonds taxable?

No, interest on eligible tax-free bonds is exempt in your hands. You should still report it as exempt income in your return. Gains from selling the bonds on the exchange are taxable.

Do I pay tax on accrued interest when I buy a bond?

The accrued interest you pay the seller is not part of the cost of the bond. You can generally reduce it from the interest you later receive. The seller treats that portion as interest income.