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Investment Knowledge / Fixed Income / Tax-Free Bonds
Fixed income guide · tax reviewed 7 September 2026

Tax-Free Bonds

Legacy notified bonds whose qualifying coupon interest is exempt; most retail access is through the secondary market.

Return: Tax-exempt coupon + price movementRisk: Issuer + interest-rate + liquidityLiquidity: Secondary-market liquidity varies
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What it is

Tax-free bonds are specific notified bonds where qualifying interest is exempt from income tax. Many well-known issues were made by public-sector or infrastructure entities in earlier years; investors today often access them through the secondary market rather than a fresh public issue.

IssuerNotified PSU / infrastructure issuers
AvailabilityMostly secondary market
CouponQualifying notified interest exempt
Key checkPurchase yield, price and remaining maturity

What can go wrong

  • “Tax-free” refers to qualifying coupon interest, not absence of all investment risk.
  • Buying above face value can reduce yield-to-maturity even when the coupon looks attractive.
  • Market prices move with interest rates, remaining maturity, credit quality and liquidity.

Tax in India

  • Qualifying interest on specifically notified tax-free bonds is exempt. Verify that the exact ISIN/issue is a notified tax-free bond; ordinary corporate bonds are not tax-free.
  • Capital gains on sale are separate from coupon exemption. A listed bond sold after the long-term holding threshold is generally subject to LTCG rules; shorter holding can be taxed at applicable rates.
  • Because coupon is exempt, post-tax comparisons can favour tax-free bonds for higher-slab investors—but only after comparing market purchase price and yield-to-maturity.

What the example below measures

The example below focuses on the tax increase caused by this instrument’s return for people starting with ₹6 lakh, ₹12 lakh or ₹50 lakh of normal taxable income. It does not treat TDS as final tax.

Tax-free bond tax: what happens to a ₹6L, ₹12L or ₹50L income person?

This is an instrument-specific illustration, not the same generic tax chart repeated on every page.

FY 2026-27 · Default new regime
Example used on this page: Assume ₹5,00,000 invested in a specifically notified tax-free bond paying an illustrative 5.5% coupon → ₹27,500 coupon income. Existing income below means normal taxable income before this investment return is added. Assumes a resident individual, no special-rate income, and includes 4% Health & Education Cess.
Existing taxable income before exempt coupon

₹6,00,000

Taxable income after coupon: unchanged
Tax on ₹27,500 coupon: ₹0

The qualifying notified coupon is exempt, so this coupon itself does not add to normal taxable income. Sale profit, if any, is a separate capital-gains question.

Existing taxable income before exempt coupon

₹12,00,000

Taxable income after coupon: unchanged
Tax on ₹27,500 coupon: ₹0

The qualifying notified coupon is exempt, so this coupon itself does not add to normal taxable income. Sale profit, if any, is a separate capital-gains question.

Existing taxable income before exempt coupon

₹50,00,000

Taxable income after coupon: unchanged
Tax on ₹27,500 coupon: ₹0

The qualifying notified coupon is exempt, so this coupon itself does not add to normal taxable income. Sale profit, if any, is a separate capital-gains question.

Important: the ₹0 above is for the notified tax-free coupon. If the bond is sold for a profit, capital-gains tax can still apply. “Tax-free bond” does not mean every possible gain from the bond is tax-free.
The three persona cards show tax on the notified coupon only: ₹0. If you sell the bond at a profit, that capital gain is a separate taxable event. Listed-bond LTCG is generally 12.5% without indexation after the current long-term holding threshold.

Tax & bond words — explained simply

No jargon without meaning. These are the terms used on this Tax-free bond page.

Notified tax-free bondA bond whose interest is specifically exempt under a Government notification / section 10(15). An ordinary corporate bond is not tax-free merely because someone calls it so.
CouponPeriodic bond interest. On a qualifying notified tax-free bond, the coupon is exempt.
Yield to Maturity (YTM)The return implied by the market purchase price, coupons and redemption value. If you buy a tax-free bond above face value, YTM can be lower than the coupon rate.
Capital gainProfit on selling the bond. “Tax-free” normally describes the notified interest, not the sale profit.
LTCG / STCGLong-Term / Short-Term Capital Gain. Listed securities generally use a 12-month long-term threshold under current rules.
IndexationInflation adjustment of purchase cost. For listed bonds transferred on/after 23 July 2024, long-term capital gains are generally 12.5% without indexation.

Official references

Use the current issuer document and current law before investing. These links are starting points for verification.

Income Tax Department — current tax law↗SEBI Investor — Understanding Bonds↗

Educational illustration, not tax or investment advice. Tax depends on residential status, tax regime, age, deductions, special-rate income, acquisition price, holding period, listing status and changes in law. “Fixed income” does not mean every instrument is guaranteed or liquid.

Compare return after tax, not only the headline rate.

Underpitch can help you compare tenure, credit quality, liquidity and post-tax yield before you invest.

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