Foundation — The two sources of income from debt, and the types of debt product

A family in Coimbatore starts a textile unit. Two outsiders put in Rs 10 lakh each.

The first takes SHARES. He becomes part-owner. He votes at the general meeting, he receives a dividend when profits allow, and if the business doubles in value, his stake doubles with it. If it fails, he may get nothing.

The second gives a LOAN, taking a debenture. He gets no vote and no dividend claim — the workbook is explicit that the debt holder would not hold any voting power or dividend claim. What he gets instead is interest during the term and the redemption value at maturity, whether the business triples or limps.

Now watch what follows for tax.

The shareholder can earn dividend (other sources, at slab rate) and capital gains on sale. The debenture holder can never earn a dividend at all — so the whole dividend apparatus of Chapter 9 is simply irrelevant to him. He earns interest while he holds, and capital gains when he sells or is redeemed.

Two sources, and only two. Every question in this chapter is answered by deciding which of the two you are looking at — and many questions demand both, computed separately, for the same bond in the same year.

A dairy in Nashik bills its customers twice a year, on 30 June and 31 December, for the six months just past.

The June bill covers January to June. But the financial year ended on 31 March. So three months of that bill — January, February and March — belong to the previous year, and three months to the current one.

This is exactly the workbook's Example 1. A 7.5 per cent bond paying half-yearly on 30 June and 31 December generates, for FY 2024-25:

Under MERCANTILE accounting — Rs 1,875 for April to June 2024, Rs 3,750 for July to December 2024, and Rs 1,875 for January to March 2025 which will only be received in June 2025. Total Rs 7,500 — a clean four quarters.

Under CASH accounting — Rs 3,750 received on 30 June 2024 and Rs 3,750 received on 31 December 2024. Total Rs 7,500 as well — but made up of different months.

Over the life of the bond both methods tax the same total. What differs is which year each slice falls into, and at the two ends of the holding — the first year and the last — the difference is real.

The test in every such problem is simple: under mercantile, ask which months the income BELONGS to. Under cash, ask which day the money ARRIVED.

A cinema in Madurai sells a Rs 100 ticket for Rs 97 if you buy it three months early. On the day of the show it is worth the full Rs 100.

Did the cinema pay you interest of Rs 3? It feels like it. But look at what actually happened: no payment of any kind was ever made to you. You simply bought something cheap and it became worth more.

That is precisely a Treasury Bill. The workbook is careful: these bills DO NOT OFFER ANY INTEREST to its investors. The return on a T-Bill is the DIFFERENCE BETWEEN THE ISSUE PRICE AND THE REDEMPTION VALUE being the face value.

And the tax consequence follows from that description: profit arising on redemption or transfer of these bills shall be considered as a SHORT-TERM CAPITAL GAIN, chargeable at the rates applicable to the assessee.

Not interest. Not income from other sources. A capital gain.

And it can never be a long-term capital gain, because a T-Bill's maturity is 91, 182 or 364 days — the instrument expires before the twelve-month door could ever open.

The same reasoning applies to Cash Management Bills, issued for usually less than 91 days as the Government's cash needs require.

A mall in Hyderabad advertises FREE PARKING in letters three feet high. Drivers park happily. At the exit gate there is a barrier, and a small sign: exit fee Rs 60.

Nobody lied. Parking was free. Leaving was not.

That is a tax-free bond. The workbook says the interest paid on these bonds is TAX-FREE in the hand of the investor, exempt under section 10. And then, immediately: HOWEVER, THE CAPITAL GAINS ARISING ON TRANSFER OR REDEMPTION OF TAX-FREE BONDS SHALL BE CHARGEABLE TO TAX. The taxability of such capital gains is SAME AS IN THE CASE OF COUPON BONDS.

The workbook's own example makes it concrete. Mr X buys NABARD tax-free bonds at Rs 120, listed, carrying 5 per cent interest, redeemable at Rs 150.

• The 5 per cent coupon: EXEMPT. No tax at all.
• The Rs 30 per bond on redemption: a LONG-TERM CAPITAL GAIN of Rs 1,50,000 on 5,000 bonds, taxed at 12.5 per cent.

The adviser's duty here is to say the quiet part aloud, because retail investors hear "tax-free bond" and understand "tax-free investment." The name describes the coupon. It says nothing about the exit.

Two investors buy corporate bonds of the same issuer on the same morning, at the same yield. One bond is listed; the other is unlisted.

Five years later they both sell at a profit of Rs 3,20,000.

The listed investor walks to a door marked LONG TERM, held for more than 12 months, and pays 12.5 per cent — Rs 40,000.

The unlisted investor walks to the same wall and finds no door at all. Table 10.1 records it plainly: for unlisted bonds the holding period is NOT APPLICABLE, and irrespective of the period of holding, gains arising on transfer will be considered as SHORT-TERM capital gains taxed at APPLICABLE RATES. In the 30 per cent slab, Rs 96,000.

Rs 56,000 of difference on identical economics, decided by a single fact neither investor may have thought about at purchase.

This is the workbook's Examples 2 and 3, set side by side precisely to make the point: the same Rs 3,20,000 gain taxed at 12.5 per cent in one case and at slab rates in the other, the only variable being whether the bond was listed.

And the same wall has no door for Market Linked Debentures — even if listed — and unlisted dated G-Secs. The adviser must check this before the client buys, because afterwards nothing about the holding period can help.

An airline offers two fares on the same flight. The full fare costs more but includes checked baggage, seat selection and a meal. The discounted fare costs much less and includes nothing — every extra is charged.

Run your eye through this chapter and you will find the same bargain over and over.

Bond interest at a concessional rate: the workbook says there are some cases where interest arising from bonds is chargeable at a CONCESSIONAL RATE and NO DEDUCTION (including deduction under sections 80C to 80U) is allowed from such interest income.

Dividend to a non-resident: taxed at 20 per cent rather than slab rates, but the assessee shall NOT be allowed to deduct ANY expenditure and Chapter VI-A deductions shall not be allowed even under the old tax regime.

Chapter XII-A for non-resident Indians: investment income capped at 20 per cent and long-term gains at 12.5 per cent, with no indexation benefit.

The pattern never varies: the lower the rate, the fewer the deductions. The Act is not being inconsistent — it is offering a package deal, and the taxpayer takes it whole or not at all.

Which is why, for a non-resident, comparing "20 per cent" against "slab rate" is never enough. You must compare the rate AND what it costs you in lost deductions.

Until FY 2022-23 a post office in Kochi sorted parcels into two bins: equity-oriented funds, and everything else.

From FY 2023-24 the sorting office installed four bins, and two of them carry date stamps.

Bin 1 — Equity-oriented funds. Unchanged.

Bin 2 — Specified Mutual Funds Type 1. Funds investing 65 per cent or more in debt or money market instruments, directly or indirectly, bought after 1 April 2023. Everything in this bin is always short term.

Bin 3 — Specified Mutual Funds Type 2. Funds investing less than 35 per cent directly in equity shares of Indian companies, bought on or after 1 April 2023 BUT SOLD BEFORE 1 APRIL 2025. Gold funds, silver funds, international funds, fund of funds, debt-oriented hybrids. Also always short term.

Bin 4 — All other mutual funds. These keep the ordinary rules — 12 months if listed, 24 months if unlisted, then 12.5 per cent.

Notice that Bin 3 has a closing date stamped on it. A gold fund bought in June 2023 and sold in March 2025 goes into Bin 3 and is short term. The same fund sold in May 2025 goes into Bin 4 and can be long term at 12.5 per cent.

Two months of patience, and a completely different tax. The exam will date a sale either side of 1 April 2025 precisely to see whether you noticed.

A trader in Jaipur sells the same fabric under two price lists — the shop's own list, and a special list for members of a particular co-operative society. A customer who belongs to that society is entitled to whichever price is lower, but he must produce his membership card.

That is the DTAA position for a non-resident. Where a non-resident is eligible for DTAA benefits, he will be taxed at a rate mentioned in the relevant DTAA OR THE INCOME TAX ACT, WHICHEVER IS MORE BENEFICIAL TO HIM.

The workbook works it both ways, deliberately.

Interest for a US resident: Article 11 of the India-USA DTAA gives 15 per cent, against slab rates under the Act. The DTAA wins.

Dividend for the same US resident: the Act says 20 per cent and the India-USA DTAA says 25 per cent. "Since the rate as per the Income Tax Act is LOWER, Mr A can opt for the tax rate under the Income Tax Act." The Act wins.

Dividend for a UK resident: the India-UK DTAA provides 10 per cent. The DTAA wins again.

So the treaty is not automatically better — it is simply the other price list, and you compare.

And the membership card matters: to claim treaty relief the non-resident must obtain a TAX RESIDENCY CERTIFICATE of his country of residence and furnish FORM 10F, a self-declaration giving prescribed details. No card, no special price.