Tax Treatment on Redemption of Tax Free Bonds

[PRIYAM KHAMBHATA]

Respected Sir

I have purchased tax free bonds face value of Rs. 1000000 from secondary market at premium price of Rs. 1100000, which are listed on BSE. I have also paid accrued interest of Rs. 75000 to the seller, then what would be the cost account for in my books of account. Either Rs. 1000000 or Rs. 1175000. Please guide me.

I am earning Interest on such bonds, which is Tax Free and I am offering such Interest Income as Exempt Income in the Return of Income. Is this correct.

Further, these tax free bonds will be redeemed at face value price of Rs. 1000000, against total payment made of Rs.1175000 towards purchase of tax free bonds, then would I claim capital loss of Rs. 175000 in the Return of Income at the time of redemption of tax free bonds, Please guide me.

Thanks

[Ryan Vaz]

Applicable Law / Circulars / Notifications

Section 10(15)(iv)(h) – Income-tax Act, 1961

Exempts interest earned on specified tax-free bonds.

Section 45 & Section 48 – Capital Gains Computation

Cost of acquisition, sale consideration, capital gain/loss.

CBDT Circular No. 2/2002, dated 15-02-2002 (very important)

Clarifies tax treatment of accrued interest paid on purchase and received on sale of securities.

CBDT Circular No. 599, dated 24-4-1991

Re: Accrued interest adjustments.

Listed securities ? holding period rule: Section 2(42A).

Short Answer

Cost of acquisition for capital gains = Purchase price excluding accrued interest = Rs. 11,00,000 – Rs. 75,000 = Rs. 10,25,000.

(Because accrued interest paid is separately deductible against interest received; it is not part of cost.)

Interest on tax-free bonds is correctly reported as exempt u/s 10(15)(iv)(h).

At redemption, where you receive only face value (?10,00,000), you will incur a capital loss = Rs. 10,00,000 – Rs. 10,25,000 = (Rs. 25,000).

Not Rs. 1,75,000, because the premium portion related to accrued interest must be removed.

AI Summary

Tax treatment of tax-free bond interest and accrued interest adjusts capital gains computation on redemption. Interest on specified tax-free bonds is exempt under Section 10(15)(iv)(h). Accrued interest paid on purchase is treated separately under CBDT guidance and is deductible against interest income; it is not included in the cost of acquisition for capital gains. Therefore, cost of acquisition for capital gains purposes equals the purchase price excluding accrued interest, and capital gain or loss on redemption/sale must be computed using that net cost.