Coupon bond
Also written Coupon bonds · Plain vanilla bond
An ordinary bond that pays periodic interest — the coupon — over its tenure and returns the face value at maturity, taxed differently depending on whether it is listed and how long it is held.
In plain language
Most bonds anyone actually buys are coupon bonds: they are issued and redeemed at face value, and in between they pay the lender periodic interest, called the coupon.
The workbook's own shorthand for reading a bond's name: "7.4% CG Bond 2027" means a Central Government bond maturing in 2027, paying a 7.40% coupon. Maturity, coupon and face value are the three features that define any coupon bond.
How it works
Two things decide how a coupon bond's capital gain is taxed: whether it is listed, and how long it has been held.
| | Holding period for long-term | Long-term rate | Short-term rate | |---|---|---| | Listed bonds or debentures | 12 months | 12.5% (without indexation) | Applicable slab/other rates | | Unlisted bonds, unlisted debentures, or Market Linked Debentures | Not applicable | — | Always short-term, taxed at applicable rates, regardless of how long held |
The interest the bond pays each period is taxed separately, under income from other sources, in the year it accrues or is received (depending on whether the assessee follows the mercantile or cash system of accounting) — it is not folded into the capital gains figure at redemption.
A bond's market value is found by discounting all its future cash flows — coupons and the final face value — back to the present at a rate called the yield-to-maturity.
A worked example
The workbook's Example 2. Mr A bought 400 listed bonds of ABC Ltd on 01-01-2016 at Rs 1,200 each (face value Rs 1,000, coupon 7% p.a., paid half-yearly on 30 June and 31 December). He sold them on 31-07-2024 at Rs 2,000 each.
Interest for FY 2024-25: half-yearly interest received on 30 June 2024 = 400 × Rs 1,000 × 7% × 6/12 = Rs 14,000; only the portion accrued from April to June 2024 (Rs 7,000) is chargeable for the year, since he sold before the December payment.
Capital gain:
Period of holding: 01-01-2016 to 31-07-2024 = 8 years 7 months → long-term (listed, > 12 months)
Full value of consideration (400 × Rs 2,000) = Rs 8,00,000
Less: Cost of acquisition (400 × Rs 1,200) = Rs 4,80,000
Long-term capital gain = Rs 3,20,000
Tax rate = 12.5%
Why NISM asks about it
Chapter 10 (Taxation of Debt Products), section 10.2.1, defines coupon bonds and Table 10.1 gives the listed-versus-unlisted holding period and rate table, with Example 2 as the full worked computation. Expect a question computing both the interest income and the capital gain on a listed coupon bond sold partway through a coupon period.
Common exam traps
- Listed bonds need only 12 months to become long-term; unlisted bonds and MLDs are always short-term, whatever the holding period.
- Interest income and capital gain are computed and taxed separately — do not net them into one figure.
- Only the interest accrued up to the sale date is taxable for that year, not the full half-yearly coupon if the sale falls before the next payment date.
- 12.5% long-term rate applies without indexation for listed bonds — indexation is not available here, unlike some other asset classes.
Check yourself
1.Which statement about tax-free bonds is correct?
- a)Both the interest and any capital gain are exempt from tax
- b)The interest is exempt under section 10 but capital gains on transfer or redemption are chargeable to tax
- c)The interest is taxable but capital gains are exempt
- d)They are exempt only for senior citizens
Show the answer
Answer: (b) The interest is exempt under section 10 but capital gains on transfer or redemption are chargeable to tax
The interest paid on these bonds is tax-free in the hand of the investor, exempt under section 10. But the workbook immediately adds: 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 the same as in the case of coupon bonds. The name describes the coupon, not the exit.
2.An investor holds an unlisted corporate debenture for five years and redeems it in FY 2025-26 at a gain. How is the gain taxed?
- a)As a long-term capital gain at 12.5 per cent, since it was held for more than 24 months
- b)As a short-term capital gain, because section 50AA makes unlisted bonds and debentures short term irrespective of the period of holding
- c)As a long-term capital gain at 20 per cent with indexation
- d)It is exempt, since debentures are excluded from the definition of capital asset
Show the answer
Answer: (b) As a short-term capital gain, because section 50AA makes unlisted bonds and debentures short term irrespective of the period of holding
The Finance Act 2024 provides that where an unlisted bond or unlisted debenture is transferred, redeemed or matures after 23 July 2024, the gains shall be taxable as SHORT-TERM capital gains under section 50AA — irrespective of the period of holding. Table 8.1 confirms the same: debentures, government securities in bond form, zero coupon bonds and other bonds are 12 months if listed but ALWAYS SHORT TERM if unlisted. Five years of holding changes nothing.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Dated Government SecurityA long-term Government security, issued by the RBI on behalf of the Centre or a state, paying a fixed or floating coupon half-yearly, with tenors from 5 to 40 years — taxed the same way as a listed bond.
- Debt oriented fundA mutual fund category investing mainly in debt securities and interest-bearing instruments — lower return than equity funds, but considered safer — with tax treatment that hinges on when the units were bought.
- Market Linked DebentureA debenture whose return is linked to an underlying index or security rather than being a fixed coupon; since Section 50AA its gains are short-term capital gains taxed at slab, whatever the holding period.
- Floating rate bondA bond whose coupon is not fixed but reset at intervals against a benchmark rate plus a stated mark-up — so the interest paid moves with market rates over the life of the bond.
- Depreciable assetA business asset on which depreciation has been claimed under the Income Tax Act — any gain on selling one is always short-term capital gain, however many years it was actually held.
- Mercantile systemThe accounting method under which interest and other income are taxed in the year they accrue, whether or not the money has been received — the alternative the Income-tax Act allows alongside the cash system.