Tax treatment at the time of bond redemption

Taxation
1

What are the tax implications of this?
https://twitter.com/SridharVarun/status/1698771168655015999

  1. Would the bond buyer have to pay income tax on full Rs 89 (8.9% interest) at marginal rate? Or the difference between buy price and redemption price including interest i.e. on Rs (1089 - 1077.44 = 11.56)

  2. If yes for tax on full interest, would they be able to claim the capital loss on redemption? Since bought at Rs 1077.44 and redeemed at Rs 1000

2

I find the phrasing in the tweet more confusing than enlightening. :thinking:
Am not quite sure what they wanted to emphasize. :person_shrugging:

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Would the bond buyer have to pay income tax on full Rs 89 (8.9% interest) at marginal rate?

Yes. That is the interest which will be received and taxed as per one’s slab-rate.

would they be able to claim the capital loss on redemption?
Since bought at Rs 1077.44 and redeemed at Rs 1000

Also yes, as this is a capital-loss.

The NCD in question is TCFSL-ND (ISIN = INE306N07KF1)
Here are the Shelf Prospectus and Tranche Prospectus for more details.

Overview:

  • Face-Value: INR 1000
  • Issue-Date: 28-09-2018
  • Coupon-Rate: 8.9% (for individuals)
  • Coupon-Frequency: Annual
  • Record-Date: 12-09-2023 (for upcoming interest payment on 28-09-2023)
  • Last Traded Price,Volume: 13,000 units around INR 1075 - INR 1080 (on 06-09-2023)

Summary:

  • one who purchased 1 unit of this NCD at INR 1079 today (06-09-2023) and holds the NCD till maturity,
  • would receive an interest payment of INR 89 on 28-09-2023.
  • and would also receive a principal repayment of INR 1000 on 28-09-2023.

i.e. ( -1079 + 89 + 1000 )

  • returns of INR 10,

    • within 22 days
    • on an investment of INR 1079

    i.e. an annualized return of (10 / 1079) * (365 / 22) = 15.3%.

  • and a capital-loss of INR 79 (for each unit one bought)
    that one can offset against any other short-term-capital-gains one may have.

NOTE: IMHO, this 15.3% is nothing spectacular for a corporate NCD,
as sovereign guaranteed treasury-bills (i.e. zero credit-risk) that were maturing later this month
were traded on NSE today yielding as high as 13% returns.

…and to further clarify the question posted in the tweet,

Is TATA paying 18% interest on its debt?

No. TATA is paying 8.9% as per the coupon rate in the NCD issue.
The rest is borne by the folks willing to sell this NCD on the secondary market at ~ INR 1079 today.

So, one naturally tends to think / ask - “Seller paagal hai kya??”
Why would anyone sell this NCD at 1079 today? :thinking:

One reason would be to book assured profits today,
instead of waiting later this month for slightly higher returns
and also bear the tiny (but non-zero) risk of delay/default by the issuer later this month.
(Maybe the sellers know aboutsome impending disaster on the issuer of the NCD,
which the buyers don’t know yet.)

Another reason, a more likley one in this case,
would be that the folks who are willing to sell off the NCD at a premium (INR 1079 for an NCD of face-value INR 1000), are receiving their returns in the form of capital-gains (presumably long-term too as the NCD issue is 5 years old). This enables such folks to get a favorable tax treatment on the returns (20% LTCG tax with indexation compared to being taxed on any interest received as per tax-slab (potentially >35% for HNIs).

(0.8 x 7.9) > (0.65 x 8.9) :brain:! :wink:

Apparently, no indexation benefits on listed NCDs. So the note within this expandable section does not apply.

Note: Furthermore, IIUC, applying indexation, one who bought the NCD at issue and sold it today,
would have zero LTCG tax liability on 7.9% gains (1000 —>1079) over 5 years
as the CII for these 5 years is around 24% (348/280).

Cost Inflation Index table from 2018 to 2023:
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1 Like
3

Thanks for the response @cvs !

The twitter thread does indicate this is likely because of the newly introduced TDS rule for bonds. More information in this thread. Post / X

However, it is interesting that such transactions can be used to bring down the tax liability from capital gains. Can this be replicated on tax-free bonds? Buy prior to interest payment dates. Sell afterwards. Any caveats apart from liquidity concerns? (edit: There is 5L limit on tax-free bond investment. ref: Tax-Free Bonds: Meaning, Features and Updated Rules)

Woah. How does one go about finding these opportunities?

4

Logically true, tax on capital gains is much less than interest income. So selling off bond at discount still makes sense.

But, for listed bonds taxation is 10% without taxation

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5

Agreed.
Monitoring NSE/BSE for 1500+ securities
for the dozen being traded at a significant discount on a given day
is something that needs automation.

i have a bespoke tool/script that i wrote for myself
that monitors/filters NSE/BSE for any Offers/Asks that fit my parameters.

While it initially thought of making it as a service,
it is not generic enough to be shared as-is
currently happy to just roll with it and keep tweaking it for my personal use.

I would suggest start by trying this manually
and once you haveidentified an approach that works for you,
then slowly automate some/all of the manual steps using an API provided by your brokerage.