TAXABILITY OF ZERO COUPON BONDS

Zero coupon bonds, also known as discount bonds, are those which do not pay any interest to

the bondholders. These are issued at heavy discount and redeemed at par. The profit is the

difference between the buying price and face value. These are also called as Deep Discount

Bonds.

As per section 2(48) of Income Tax Act, zero coupon bonds must satisfy the following

conditions:

1. Bond should be issued by any Infrastructure Capital Company or Infrastructure Capital

Fund or Public Sector Company on or after 1 st June, 2005.

2. No payment/benefit is received before maturity or redemption from Infrastructure

Capital Company or Infrastructure Capital Fund or Public Sector Company. (or schedule

banks with effect from 1 st April 2009.)

3. These bonds must be notified by the Central Government in the Official Gazette.

TAX TREATMENT:

I. IN THE HANDS OF COMPANY ISSUING SUCH BONDS:

 Discount given will be allowed as deduction on pro-rata basis with regard

to the life of the bond.

 No TDS will be deducted on income or maturity/ redemption of zero

coupon bonds U/s 194A(3)(x) of Income Tax Act.

II. IN THE HANDS OF INVESTOR:

 Zero coupon bonds are taxable under two heads depending upon how

the bond is held.

 If the bonds are held as capital asset, these are taxable under the head

“Income from Capital Gains". These can be short term or long term

depending upon the holding period. i.e. 12 months.

 Long term Capital gains will be taxable at the rate of 10%+ cess. No

indexation benefit is available.

 If bonds are held as investments, these are taxable under the head

“Profit and gains from business and profession”.

Zero coupon bonds are ideal for people who require funds at specific period of time in the

future like children’s education or retirement. Also, if you are not interested in watching the

market trends and like the comfort of the ‘invest and forget’ strategy, then you can consider

zero coupon bonds. If your investment portfolio primarily consists of growth investments and

you are looking to add diversity to it, then zero coupon bonds can help you secure a guaranteed

return for a fixed time period. Finally, these bonds tend to offer great discounts for longer

tenures of investment and are perfect for long-term investment plans.