How is the profit on my bond sale taxed?

The excess amount over the face value represents expenses incurred for earning the interest income and therefore can be claimed as a deduction. (istockphoto)
The excess amount over the face value represents expenses incurred for earning the interest income and therefore can be claimed as a deduction. (istockphoto)

Summary

  • The tax treatment of interest remains consistent regardless of whether the securities are listed on the stock market

Three months ago, I bought IFCI bonds, issued on 1 August 2011, for 34,000. The date of maturity of these bonds, with a face value of 10,000, is 1 August 2026. On maturity, IFCI will pay 10,000 as capital and 36,250 as interest, subject to tax deducted at source, or TDS. Can I show this amount received ( 46,250 less TDS) as sale proceeds in my income tax returns and claim long term profit? Note that there was no TDS till last year in the earlier IFCI bond series that matured in 2021-22.

—Vijay Desai

In accordance with Section 56 of the Income Tax Act, income in the nature of interest is subject to taxation under the head ‘Income from other sources.’ This encompasses all types of interest, including those from bank accounts, fixed deposits and debentures, whether convertible or non-convertible.

Notably, the tax treatment of interest remains consistent regardless of whether the securities are listed on the stock market. However, taxpayers possess the flexibility to declare this income for taxation either on an accrual basis—when the interest income becomes due—or on a receipt basis—when the interest is received in their bank account.

Thus, the cumulative amount of 36,250 received at the time of redemption of the bonds would qualify as interest and hence taxable at the applicable slab rate.

With regards to the purchase price of the bonds amounting to 34,000, there are two contrasting perspectives on its treatment. The first posits that the excess amount paid by the taxpayer over the face value constitutes a capital loss. In this instance, a capital loss of 24,000 (purchase price 34,000 less face value 10,000) is incurred. However, it is crucial to note that such capital losses cannot be utilized to offset the interest income. However, the same can be utilized to set off other capital gains income either in the year of maturity or carried forward for up to eight subsequent assessment years.

The second suggests that the excess amount over the face value represents expenses incurred for earning the interest income and therefore can be claimed as a deduction. Under this scenario, the interest income would be 36,250, and the deduction would amount to 24,000. Consequently, only the net income of 12,250 would be subject to taxation. This option is open to debate and may not be readily accepted by the income tax officer.

As stipulated in section 193 of the Act, any entity responsible for disbursing interest income on securities to a resident is obligated to deduct tax at source. In the case of interest payable to an individual or a Hindu Undivided Family (HUF) resident in India, on debentures issued by a publicly-interested company, TDS is applicable only if the aggregate interest amount exceeds 5,000 during the financial year. The TDS deducted can be claimed as a credit in the year in which the income is subjected to taxation. Note that TDS should not be deducted from the taxable income; instead, credit should be claimed against the income tax payable and the amount becomes refundable to the taxpayer if no income tax is payable.

Neeraj Agarwala is partner, Nangia Andersen India.

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