Taxation of investments in Bonds, Debentures & Mutual Funds
With the drastic fall in the interest rate of bank FDR, an alternate investment option like bonds, debentures, mutual funds are getting added momentum. Income from bonds, debenture & mutual funds could be as under:
- Regular income in the form of interest or dividend
- Appreciation in the value of the investment at the time of redemption or sale.
Tax treatment of above income varies significantly. Let us have a look at the taxation aspect of all above income out of the investments referred above:
- Taxation of Interest:
Interest income from bonds (including gold sovereign bond) & debentures is similar to any other interest income like interest income from FDs and it will be taxable at normal rates under the head ‘Income from other sources’. However, interest received on investment done in various tax-free bonds is exempt from tax.
- Taxation of Dividend:
Dividend received from investment in shares is now taxable if the amount exceeds Rs. 10 Lakh. It is taxable at a special rate of 10% u/s 115BBDA. However, U/s 10(35) dividend income from mutual funds is still tax free without any limit whether it is received from equity fund or debt fund or balanced fund.
- Taxation of Appreciation in the value of investments:
Under the Income Tax Act-1961, Gain or profit arising out of the investment activity is normally termed as capital gain. The tax treatment for appreciation in the value investment is as under:
I] In case of Debentures & Bonds:
a] Zero Coupon Bond:
Tax liability on transfer/redemption of zero coupon bonds may be either short term (if held for not more than 12 months) or long term. In cases where the tax payable in respect of long-term capital gain arising from transfer of a zero coupon bonds exceeds 10% of the amount of capital gains without indexation then such excess shall be ignored.
b] Other Bonds & Debentures:
Taxation will depend on the on the period of holding. Bonds & debentures held for more than 36 months is considered as Long Term and profit would be treated as Long Term Capital Gain (LTCG), else it will be treated as short term and profit would be Short Term Capital Gain (STCG). In case of listed bonds & debentures, the holding period of 36 months as referred above need to be taken as 12 months only. LTCG & STCG is required to be computed simply by reducing the cost of acquisition of such bonds from the sale/redemption price. For LTCG in respect of Capital Indexed Bonds issued by the Government & Sovereign Gold Bonds issued by the RBI, investors are eligible for indexation benefit whereby cost of acquisition can be enhanced to compensate the inflation. LTCG as referred above is taxable at a flat rate of 20% whereas STCG is treated like other regular income of the taxpayer & taxable as per applicable tax slab rate for the taxpayer.
II] Mutual Funds:
Apart from holding period, mutual funds taxability would depends upon on the nature of fund i.e., debt fund, equity fund, balanced fund, arbitrage fund etc. The same is summarized as under:
i] Debt Fund:
If the investment period in debt fund is not exceeding 36 months then returns would be considered as STCG which is treated like any other income of the taxpayers & taxable as per the applicable income tax slab of the taxpayers. If debt investments are held for a period exceeding 36 months then returns would be considered as LTCG which is taxable at a special tax rate of 20% with indexation benefit.
- ii) Equity Fund:
If the mutual funds invests more than 65% of its corpus in equities, it would be treated as Equity Oriented Mutual Fund (EOMF). Even Arbitrage funds, Equity-Linked Saving Scheme (ELSS) & balanced funds are considered as EOMF for taxation.
If investment is redeemed after a holding period of more than 12 months then returns would be treated as LTCG which is exempt from tax up to overall cap of Rs. 1 lakh and amount exceeding Rs. 1 Lakh is taxed @ 10% without any indexation benefit. However, appreciation in the value of the EOMF till 01.02.2018 will not be taxable due to grandfathering provision incorporated by the FA-2018.
If the investment in EOMF is redeemed within 12 months, returns would be treated as STCG which is taxable at a special rate of flat 15% u/s 111A of the Income Tax Act-1961. There is no change by the Finance Act- 2018 for taxation of STCG of equity mutual funds.