Accrued interest in sale consideration

A bond sold between two interest-payment dates carries some interest that has already built up but has not yet been paid to anyone. That built-up interest usually gets folded into the price the buyer pays. If it stayed inside the sale price for tax purposes, it would be taxed twice — once as part of the capital gain, and again when the interest itself is later paid out.

Tax law does not allow that. The interest portion is pulled out and taxed on its own, as interest income, and the sale price used for capital gains is adjusted downward by the same amount — the accrued interest in the sale consideration.

Step 1 — identify the interest. Work out how much interest has accrued, but not yet been received, between the last interest payment date and the date of sale.

Step 2 — tax it as interest income, following Section 145's mercantile or cash system as applicable to the assessee.

Step 3 — strip it from the sale price before computing capital gains:

Adjusted sale consideration = Full sale price − Accrued interest included in that price
Capital gain = Adjusted sale consideration − Cost of acquisition

Without this adjustment, the same rupees of accrued interest would be counted once as part of the sale price (inflating the capital gain) and again when the buyer eventually receives the actual interest payment — a double taxation that the adjustment is specifically designed to prevent.

Mr A buys a 9% listed bond, face value Rs 10,000, on 1 April 2024 for Rs 10,500. Interest is paid quarterly. He receives interest for the quarters ending 30 June and 30 September 2024, then sells the bond on 1 November 2024 for Rs 13,000, a price that includes interest accrued since 30 September.

Interest income:

Capital gain, after stripping out the accrued interest:

Sale consideration                        13,000
Less: accrued interest already taxed above   (75)
Adjusted sale consideration               12,925
Less: cost of acquisition                (10,500)
Short-term capital gain                    2,425

The bond was held for 7 months, so the gain is short-term, taxed at Mr A's applicable rate. The Rs 75 of accrued interest is taxed once, as interest income — not folded a second time into the capital gain.

Chapter 10 (Taxation of Debt Products), section 10.2.1, works through this exact adjustment on Coupon Bonds — computing interest income first, then the "adjusted sales consideration" for capital gains. Expect a two-part computation question: interest income for the year, followed by capital gains using the sale price net of the accrued interest already taxed.

• The accrued interest is taxed once, as interest income — not as part of the capital gain. Forgetting to strip it out of the sale price double-counts it.
• The adjustment reduces the sale consideration used for capital gains, it does not reduce the actual amount the seller physically receives.
• The interest figure depends on whether the seller follows the mercantile or the cash system — under mercantile, interest accrued but unpaid at sale is still taxable that year; under cash, it would not be, until actually received.
• This is distinct from the ordinary half-yearly or quarterly coupon already received before the sale — only the portion accrued and unpaid at the point of sale needs this adjustment.