Will I have to pay tax on selling tax-free bonds before maturity?

Two types of bonds issued by the Government offer tax exemptions: tax-free bonds, which provide tax-free interest, and capital gains bonds under Section 54EC, which help investors save tax on capital gains from selling property.

This article will quickly help you understand the tax implications of selling these bonds before maturity.

Let’s start with the tax-free bonds.

Tax on selling tax-free bonds before maturity

The Government of India has not issued new tax-free bonds for a long time. However, many investors continue to hold these bonds.

For instance, one of our readers, Lalit Sedani, recently shared that he has invested in six tax-free bonds that will mature after 2028. He had purchased these bonds between 2018-2020.

He has been receiving tax-free interest from these bonds every year, but he now wants to know about the tax implications of selling these bonds before maturity.

The answer is yes, tax will apply if he sells tax-free bonds before maturity.

Although the interest earned on these bonds is tax-free, any capital gain from their sale in the secondary market is taxable.

For example, if you sell your tax-free bond at a price higher than the cost on the stock exchange, then you would have to consider the difference as a capital gain, and it will be taxed as follows:

• Short-term capital gains at 20% (if sold before 12 months)
• Long-term gains at 12.5% if sold after 12 months, without indexation.

As the Government has not issued these bonds for many years, only LTCG at 12.5% will apply if an investor sells these bonds now on the stock exchanges before maturity.

What about the capital gains bonds?

One can invest LTCG from selling a property in these bonds for five years to avoid tax. While initial investment in these bonds is exempt from tax, premature selling may result in capital gains tax.

“In case where a taxpayer has availed capital gains tax exemption under Section 54EC, selling bonds such as those issued by Power Finance Corporation, HUDCO, NHAI, REC, or Indian Railway Finance Corporation before the expiry of the lock in period of 5 years may result in capital gains, which are taxable depending on the period of holding,” said CA Dr Suresh Surana.