How Bond Interest Is Taxed in India: TDS, ITR Filing and Slabs
Imagine you've just received a coupon payment of ₹8,500 on your NCD — but only ₹8,075 lands in your bank account. Where did ₹425 go, and is that all you owe the government? Or consider a retiree in the 5% tax slab who just realised they may have overpaid TDS on their government bond interest. These are the quiet surprises that catch even careful bond investors off guard.
Bond interest taxation in India isn't complicated once you understand its structure, but it has enough moving parts — TDS thresholds, slab-rate treatment, special exemptions for certain bonds, ITR form selection — that ignoring it can meaningfully shrink your take-home returns. This post explains the full picture: how TDS works on bonds, which instruments get special treatment, how your tax slab determines what you actually owe, and how to report everything correctly when you file your return.
Key Takeaways
- Bond interest is taxed as "Income from Other Sources" at your applicable income tax slab rate — there is no concessional flat rate for most bonds.
- TDS is deducted at 10% once interest crosses ₹5,000 per financial year from a single issuer (for resident individuals); this is an advance deduction, not your final liability.
- Listed bonds held for more than 12 months attract Long-Term Capital Gains (LTCG) tax at 12.5% (without indexation) on price gains; this is separate from coupon interest taxation.
- Unlisted bonds do not get the 12.5% LTCG benefit — both coupon income and capital gains are taxed at slab rate.
- Tax-free bonds (certain PSU issues from 2013–2016 onwards) are a genuine exception — coupon income is entirely exempt under Section 10(15)(iv), though capital gains on secondary market trades are taxable.
- Sovereign Gold Bonds and 54EC bonds have their own tax rules — understanding these nuances matters if you hold either instrument.
- Use ITR-2 if bonds are your only additional income source beyond salary; use ITR-3 if you trade bonds frequently enough to be classified as a business.
- Always reconcile TDS credits in Form 26AS and AIS before filing — mismatches are one of the most common causes of ITR processing delays.
How Bond Interest Is Classified for Tax Purposes
The Slab Rate Default
When you earn a coupon payment from a bond — whether it is a corporate NCD, a government security, a State Development Loan, or a listed PSU bond (unless it is an explicitly tax-free issue) — the Income Tax Act treats that income as "Income from Other Sources" under Section 56(2). This means it is added to your total taxable income and taxed at whichever slab rate applies to your bracket.
For FY 2025–26, under the new default regime, the slabs are:
| Income Slab | Tax Rate |
|---|---|
| Up to ₹4,00,000 | Nil |
| ₹4,00,001 – ₹8,00,000 | 5% |
| ₹8,00,001 – ₹12,00,000 | 10% |
| ₹12,00,001 – ₹16,00,000 | 15% |
| ₹16,00,001 – ₹20,00,000 | 20% |
| ₹20,00,001 – ₹24,00,000 | 25% |
| Above ₹24,00,000 | 30% |
(Add 4% Health and Education Cess on income tax computed. Surcharge applies for higher income brackets.)
This has a direct, material impact on net yield. A bond offering 8.5% gross coupon delivers approximately 8.5% to an investor in the nil slab, around 8.1% to a 5% taxpayer, roughly 7.7% after tax at the 10% slab, and only approximately 5.9% net to someone in the 30% bracket (before cess). Comparing bond yields and bank fixed deposit rates on a pre-tax basis without accounting for your slab can lead to misleading conclusions.
The Special Case: Tax-Free Bonds
Certain bonds issued by Public Sector Undertakings (PSUs) like NHAI, REC, PFC, IRFC, and HUDCO under specific government authorisations carry a Section 10(15)(iv) exemption. The coupon income from these bonds is fully exempt from income tax in the hands of the investor, regardless of slab.
If your effective tax rate is high, the after-tax yield on a tax-free bond paying 7.5% can easily exceed the after-tax yield on a taxable bond paying 9.5%. Our dedicated tax-free bonds guide walks through how to evaluate this trade-off using the tax-equivalent yield formula. New issuances of these bonds have been rare since 2016, so most available supply is on the secondary market — capital gains on secondary market trades remain taxable.
How TDS Works on Bond Interest
The Basic Mechanism
Tax Deducted at Source (TDS) on bond coupon payments is governed primarily by Section 193 of the Income Tax Act. When the issuer or paying entity credits or pays interest to you, they are legally required to deduct TDS before disbursing if the amount crosses the threshold.
Threshold for resident individuals: TDS kicks in when interest income from a single issuer exceeds ₹5,000 in a financial year. Once crossed, TDS is deducted at 10% on the entire interest amount (provided you have furnished your PAN; otherwise, the rate is 20%).
Key TDS facts:
- TDS is not your final tax. It is an advance deduction against your tax liability. If your actual slab rate is lower (or you are in the nil bracket), you can claim a refund when filing your ITR.
- If your slab rate is higher than 10%, TDS alone does not settle your liability — you will owe additional self-assessment tax.
- Listed government securities held through RBI Retail Direct and certain exchange-traded G-Secs: Interest paid by the RBI on G-Secs held in the Retail Direct scheme is subject to TDS at 10% above the ₹10,000 threshold (Section 194A applies here; Section 193 has an exemption for listed debentures held in demat form in some cases — read the specific bond's terms carefully).
- Dematerialised listed NCDs: Many listed NCDs held in demat form through exchanges are covered under Section 193, but there has been regulatory evolution here. Confirm the TDS treatment in the issuer's information memorandum or the platform's FAQs.
Checking Your TDS Credits
Every TDS deduction should appear in your Form 26AS (Tax Credit Statement) and Annual Information Statement (AIS), both accessible on the Income Tax portal. Before filing, reconcile:
- Coupon income received (sum of all payments across issuers)
- TDS deducted (as shown in 26AS/AIS)
- Any discrepancy between your records and 26AS
Discrepancies often arise when issuers file TDS returns late or with errors. If your TDS credit is missing, raise a rectification request or contact the issuer's Registrar and Transfer Agent. Filing your ITR with uncreditable TDS leads to demand notices.
Submitting Form 15G / 15H
If your total taxable income is below the basic exemption limit and your interest income is below the threshold, you can submit Form 15H (for senior citizens) or Form 15G (for others) to the issuer at the start of the financial year to request nil TDS deduction. This is not a tax exemption — it is a declaration that your actual liability will be zero. Providing a false declaration attracts penalties under Section 277.
Capital Gains on Bonds: A Separate Tax Layer
Coupon income and capital gains are two distinct tax events. If you sell a bond on the secondary market at a price different from your purchase price, the gain or loss is a capital gain.
Listed Bonds (Held in Demat, Traded on Exchange)
| Holding Period | Gain Classification | Tax Rate |
|---|---|---|
| 12 months or less | Short-Term Capital Gain (STCG) | Slab rate |
| More than 12 months | Long-Term Capital Gain (LTCG) | 12.5% (no indexation) |
The shift to 12.5% LTCG without indexation (effective from Budget 2024) means that earlier indexation benefits no longer apply. For most buy-and-hold bond investors who intend to receive coupons and hold to maturity, this is irrelevant — but if you are actively exiting a bond before maturity to capture price appreciation or manage duration, the tax treatment of the gain matters.
Unlisted Bonds
Both STCG and LTCG on unlisted bonds are taxed at slab rate, regardless of holding period. There is no concessional 12.5% LTCG rate for unlisted instruments. This is one of the reasons investors and tax advisers often prefer listed bonds over unlisted ones for secondary market transactions.
54EC Bonds: Capital Gains Reinvestment Exemption
If you have sold a long-term capital asset (property, land) and want to save on capital gains tax, you can invest up to ₹50 lakh in Section 54EC bonds issued by NHAI, REC, or PFC. The coupon on these bonds — typically around 5.25% — is fully taxable at slab rate. The tax benefit is only on the capital gains from the original asset sale, not on the bond's interest income itself. This distinction trips up many first-time 54EC investors.
Which ITR Form Should You Use?
Filing in the wrong ITR form is a common mistake that triggers defective return notices. Here is a practical guide:
| Your Situation | ITR Form |
|---|---|
| Salary + bond interest income only (no capital gains, no business income) | ITR-1 (Sahaj) — if interest income ≤ ₹50 lakh and no capital gains |
| Salary + bond interest + capital gains from selling bonds on exchange | ITR-2 |
| Bond interest + capital gains + any other income (no business income) | ITR-2 |
| Frequent bond trading treated as business/profession | ITR-3 |
| HUF or firm with bond income | ITR-3 |
Practical tip: Most individual retail bond investors who hold bonds for regular coupon income and occasionally sell will use ITR-2. The Schedule OS (Other Sources) captures coupon income; Schedule CG captures any capital gains. TDS credits flow from your 26AS into the Tax Credit Schedule.
If you are unsure whether your trading activity crosses the threshold to "business income," consult a tax professional. The frequency and volume of trades, whether you treat it as your primary occupation, and how you characterise it in past returns all matter.
Common Mistakes Bond Interest Taxpayers Make
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Treating TDS as final tax. Many investors in the 20–30% slab assume that because TDS was deducted, their tax obligation is settled. It is not. The differential must be paid as self-assessment tax before or at the time of filing, and interest under Section 234B/C may apply if advance tax was not paid.
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Missing interest from unlisted or privately placed bonds. Bonds held in demat that are not exchange-listed may not always generate automatic TDS, or TDS details may not appear prominently in 26AS. Investors sometimes omit this income while filing, creating exposure to scrutiny.
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Confusing tax-free bond coupon exemption with capital gains exemption. The Section 10(15)(iv) exemption covers coupon income only. If you buy a tax-free bond on the secondary market at a premium and sell it later, any capital gain is taxable. The two tax treatments are independent.
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Ignoring accrued interest in cost basis calculations. When you buy a bond in the secondary market, part of what you pay is accrued interest (the dirty price premium over clean price). This accrued interest is not your capital cost — it is treated as interest income received when the next coupon is paid. Incorrectly including it in your cost of acquisition inflates your capital loss claim. See our explanation of how bond prices and accrued interest work for more detail.
Frequently Asked Questions
Is bond interest taxed differently from FD interest?
No — both are taxed as "Income from Other Sources" at your applicable slab rate. The TDS mechanism is similar: banks deduct TDS on FD interest above ₹40,000 (₹50,000 for senior citizens), while bond issuers deduct at ₹5,000. The key difference is that listed bonds held for over 12 months get the 12.5% LTCG rate on price appreciation, whereas FD premature withdrawal penalties and the principal are not capital assets. If comparing bonds and FDs purely on after-tax income, the slab-rate treatment is identical for coupon/interest income.
Do government bonds (G-Secs) attract TDS?
Interest on G-Secs (Central Government securities) is subject to TDS under Section 193 in most cases. However, there is a specific exemption for interest on 8% Savings (Taxable) Bonds 2003 and certain notified securities. For G-Secs held through the RBI Retail Direct scheme, TDS applies above ₹10,000 per year. Verify the specific TDS treatment for each security through the RBI Retail Direct platform or the bond's terms, as exemptions are instrument-specific.
If I'm in the nil tax bracket, how do I get a TDS refund?
Submit Form 15G to the issuer before the first coupon payment of the financial year to request no TDS deduction. If TDS has already been deducted, file your ITR declaring the full coupon income and your nil tax liability. The excess TDS will appear as a refund. Ensure your bank account is pre-validated on the Income Tax portal for smooth refund credit. Refunds are typically processed within a few weeks of ITR verification.
Are coupon payments from Sovereign Gold Bonds taxable?
Yes. The 2.5% per annum coupon on Sovereign Gold Bonds (SGBs) is fully taxable as "Income from Other Sources" at your slab rate, and TDS applies. However, the capital gains on redemption at maturity (after 8 years) are completely exempt for individual investors. Premature redemption through the RBI's buy-back window also enjoys LTCG exemption. Secondary market sales of SGBs on exchanges attract normal capital gains taxation. Our Sovereign Gold Bonds guide covers this in more detail.
Which schedule in ITR-2 captures bond interest income?
Bond coupon income goes into Schedule OS (Income from Other Sources). Break it down issuer-wise or at a minimum show the total. Capital gains from bond sales go into Schedule CG — short-term gains in the STCG section (taxed at slab) and long-term listed bond gains under the 12.5% LTCG provision. TDS credits are captured in the Tax Credit Schedule (Schedule TDS), which auto-populates from 26AS data in most ITR filing utilities.
Does investing in bonds through bond funds (mutual funds) change the tax treatment?
Yes, significantly. If you invest in bonds through a debt mutual fund rather than directly, the fund's income is not passed through as "bond interest" to you. Instead, your returns are taxed entirely as capital gains on the fund units you hold. Since the Finance Act 2023, debt mutual funds (funds with less than 35% in equities) no longer enjoy indexation benefit or the 20% LTCG rate — gains are taxed at slab rate regardless of holding period. Direct bond ownership (for listed bonds held over 12 months) currently retains the 12.5% LTCG rate on price gains. The bond funds vs direct bonds comparison explores this trade-off in depth.
Bottom Line
Bond interest in India is taxed at your slab rate — there is no special flat rate for most instruments. TDS at 10% is an advance collection, not a final settlement; higher-bracket investors owe more, lower-bracket investors can reclaim the excess. The notable exceptions — tax-free PSU bonds, the LTCG rate on listed bonds held beyond 12 months, and redemption exemptions on SGBs — are real advantages worth understanding before you build your portfolio. Match your ITR form to your income profile, reconcile your 26AS before filing, and factor your post-tax yield into every comparison. For a broader view of how bond selection and tax-efficient planning work together, that context is just as important as the mechanics covered here.
Disclaimer: This post is for educational purposes only. BondDekho is not a SEBI-registered investment adviser. Yields and risks mentioned are illustrative; consult a SEBI-registered adviser before making any investment decision.