How is tax on NCDs calculated?

Reader Kanti Kiran emailed me with a couple of corrections related to taxation of NCDs post that I wrote yesterday, and I’m going to talk about them in this post.

I said that the cumulative NCD option is not tax free, and that the money you get during the redemption will attract capital gains.

Kanti Kiran wrote to me saying this isn’t correct, and while the amount is taxable, it’s not taxable as capital gains, but as interest income that will be clubbed with your other income and taxed at your regular tax rate.

This is a meaningful difference because people at the highest tax rate will have to pay about 30% tax on this income instead of the lower capital gains tax rate.

There was another reader who weighed in on the subject, and he opined that if there is a coupon rate associated with the NCD, and if that NCD pays out a cumulative option then you have to declare the income every year, and pay tax on that much like the tax on recurring deposits.

However, if there is no coupon rate on the NCD and they pay a lump-sum amount then that will be treated as capital gains. It’s not quite clear to me how a coupon rate gets associated to a cumulative NCD.

I couldn’t find an authoritative source on any of this, so if any of you have practical experience or know for sure how this income should be treated then please leave a comment or email me.

There was also a comment on treating capital gains on these NCDs in the same way that you would treat the capital gains on shares if you buy or sell the NCDs on the stock exchange.

The rationale for treating them as equity funds is that you pay Securities Transaction Tax (STT) on these transactions. I checked with Shiv on the transactions that he has done on the exchange, and he hadn’t paid any STT on the NCD he sold, so it doesn’t look like you can treat capital gains on NCDs in the same way as equities.

The last point was about no TDS on only those NCDs that are listed and are compulsorily in Demat form. You will remember that this is what we talked about when infrastructure bonds were issued last year when many of them were first compulsorily Demat and then turned into physical form, and a bit of confusion ensued.

Since one of the main features of these NCDs is listing in an exchange, and they are seeing a lot of demand from people who have Demat accounts – I don’t see them changing this aspect of the NCD, but it’s a good point to keep in mind.

So, these are the various interpretations of the tax on NCDs that have been shared so far, and I will appreciate any feedback that you may have on this.

Thanks to Kanti Kiran, ankm83 and Shiv for weighing in and giving input for this post, and I apologize to everyone for not getting this right on the first go.