Zero-Coupon Bond Taxation

Zero-Coupon Bond Taxation – A zero-coupon bond is a type of debt instrument issued at a discount and redeemed at face value, without paying periodic interest (coupon). The difference between the purchase price and the redemption value represents the interest income, which is taxable on an accrual basis under the Income Tax Act. For investors, the annual accrued interest (difference between discounted value and face value spread over the bond’s tenure) is treated as income from other sources or business income, depending on the nature of the holding. Additionally, if the bond is sold before maturity, capital gains tax may apply based on the holding period—short-term or long-term.

Example: An investor buys a zero-coupon bond for ₹1,00,000 and redeems it at ₹1,20,000 after maturity. The ₹20,000 gain is treated as taxable interest income (if held to maturity) or as capital gain (if sold earlier)