Budget 2023 introduced a 10% tax deducted at source (TDS) on coupon payments from listed bonds. While the intention was to ensure tax compliance, it created unforeseen complications for individuals—especially small investors and retirees who rely on predictable coupon income.
TDS is a system that collects tax at the source of income distribution. In the context of bonds, it means the entity paying the coupon deducts 10% as tax and deposits it with the government. Although this seems straightforward, there are several obscured issues in how TDS applies to bonds—particularly in secondary market transactions.
When bonds are traded between coupon payment dates, the buyer compensates the seller for accrued interest. However, when the coupon is paid, the new buyer receives the entire amount for the period, with 10% TDS deducted on the full amount.
The buyer is effectively taxed on the entire coupon even though a portion of the interest pertains to the period when the bond was held by the previous owner. This causes a discrepancy in cash flows and can erode the expected yield or returns initially anticipated.
How are retail investors affected?
Small or retail investors often invest in bonds to earn predictable returns. TDS affects them by interrupting cash flow and complicating filing requirements as excessive TDS deductions require claiming refunds.
One of the critical challenges is the reflection of coupon interest in Form 26AS, which compounds the complications surrounding TDS. Investors have pointed out that the entire coupon amount is shown as “interest paid” in Form 26AS, although a portion of this interest was already compensated as accrued interest at the time of purchase in the secondary market.
This misrepresentation in the AIS (annual information statement) creates additional hurdles. When filing their tax returns, investors must reconcile these discrepancies, often leading to additional scrutiny during the tax assessment process, requiring them to provide clarifications or supporting documentation.
Such situations might force investors into paying tax on income that has already been adjusted and taxed during the purchase process. This issue disproportionately affects small and retail investors, who may lack the resources or expertise to navigate these complexities, further diminishing the appeal of bonds as an investment option.
As TDS complicates the coupon and price calculations, it can make small investors wary of trading in the secondary market. This could lower liquidity in the bond market, further reducing the attractiveness of bonds as an easily tradable investment.
Special challenges for senior citizens
For senior citizens who typically depend on regular interest or coupon income, the TDS rules pose additional hurdles:
· Form 15G/15H exemption: Senior citizens can avoid TDS by submitting Form 15G/15H, but the process is not always seamless. Mistakes, delays, or lack of proper guidance can lead to unintentional deductions.
· Reliance on coupons for living expenses: Senior citizens often use coupon income to meet day-to-day expenses. If TDS is unexpectedly deducted, they must wait to get a refund—impacting their short-term cash flow and overall financial planning.
Potential remedies
1. Reconsider TDS on listed bonds: A rollback or recalibration of TDS on coupon payments could remove the unpredictability that small investors face. It would eliminate administrative burdens associated with refunds and tedious tax processes.
2. Clearer guidelines and investor education: The government and regulatory bodies could issue detailed guidelines on how TDS should be applied in secondary market transactions, especially clarifying how accrued interest should be treated.
3. Better exemption filing process: For those eligible for exemptions (Form 15G/15H), creating a centralised online, user-friendly process could significantly reduce errors. This would help ensure that the correct amount of tax is deducted, or not deducted at all, in the first place.
4. Encourage wider retail participation: A simplified tax framework could stimulate investor confidence and deepen the market.
The introduction of TDS for listed bonds was meant to equalise the rules across asset classes. Fixed-income investments are very sensitive to cash flows and meant for low-volatility regular returns, unlike equities. So, taxation should be cognisant of the asset class as well.
The 10% TDS on listed bond coupons, though well-intentioned for tax compliance, has added complexity that disproportionately affects small bond investors. Revisiting these rules to account for secondary market transactions and simplify exemption processes would foster a more inclusive environment for small investors while supporting India’s bond market growth.
Vishal Goenka is co-founder of IndiaBonds.com
