Zero coupon bonds (ZCBs) are a cornerstone instrument for long-term infrastructure financing in India. Unlike regular bonds that pay periodic interest, ZCBs are issued at a deep discount and redeemed at face value on maturity-the entire return is locked in at issuance, providing certainty for both the issuer and the investor. For issuers, the discount is deductible as a business expense over the bond’s life. For investors, the return is taxed as capital gains rather than interest, with no TDS and no annual tax obligation until sale or maturity.
Under the Income Tax Act, 2025 (effective 1 April 2026), the definition of ZCB is in Section 2(112), and the notification procedure is prescribed in Rule 7 of the Income Tax Rules, 2026 (notified on 20 March 2026 via G.S.R. 198(E)). Only ZCBs notified by the Central Government in the Official Gazette receive the special tax treatment. This guide covers the complete lifecycle: who can apply, the application procedure, notification conditions, post-notification compliance, issuer tax benefits, investor tax treatment, and practical considerations. For infrastructure entities managing income tax return filing (https://www.patronaccounting.com/income-tax-return), understanding the ZCB notification framework is critical for accessing the tax-efficient financing this instrument offers.
Who Can Issue Notified Zero Coupon Bonds?
Under Rule 7(1), the following entities are eligible to apply for ZCB notification:
| # | Entity Type | Required Document | Legal Basis |
|---|---|---|---|
| 1 | Infrastructure capital company | Certificate of incorporation under Companies Act, 2013 | Rule 7(4)(a) |
| 2 | Infrastructure capital fund | Trust deed registered under the Registration Act, 1908 | Rule 7(4)(b) |
| 3 | Infrastructure debt fund | Certificate of incorporation (if company) or trust deed (if trust-based NBFC) | Rule 7(4)(a)/(b); Schedule VII Table Sl. No. 46 |
| 4 | Public sector company - Government company (Section 2(45), Companies Act 2013) | Certificate of incorporation under Companies Act, 2013 | Rule 7(4)(a) |
| 5 | Public sector company - Statutory corporation (established by Central/State/Provincial Act) | Copy of the relevant establishing Act | Rule 7(4)(c) |
For entities registered through company registration (https://www.patronaccounting.com/private-limited-company-registration) as infrastructure capital companies or Section 8 infrastructure funds, the ZCB notification process enables access to long-term, tax-efficient debt capital for infrastructure projects.
Application Procedure: Step-by-Step
- Prepare Form 2. Complete the prescribed application form with details of the proposed ZCB issuance: entity details, bond particulars (tenure, face value, issue price, proposed issue date), and compliance undertakings.
- Attach required documents. Certificate of incorporation (companies), trust deed (funds), or establishing Act (statutory corporations). Include credit rating letters from two SEBI-registered agencies and stock exchange listing arrangement letter.
- File at least 3 months before issue date. Under Rule 7(1), the application must be submitted at least 3 months prior to the proposed date of bond issuance. Late applications will not be entertained.
- Application validity: Under Rule 7(2), applications cannot be made for bonds proposed to be issued beyond 2 financial years following the financial year of application. This prevents speculative or indefinite-horizon applications.
- Central Government disposes within 6 months. Under Rule 7(3), the application must be disposed of within 6 months from the end of the month in which the application was received. The Government may call for additional information during this period.
- Notification in Official Gazette. If all conditions are satisfied, the Central Government notifies the ZCB in the Official Gazette with details including: name of the issuing entity, bond description, issue price, face value, maturity date, credit rating, and stock exchange listing details.
- Rejection with hearing. Under Rule 7(7), if conditions are not fulfilled, the Government may reject the application after giving a reasonable opportunity of being heard to the applicant. For entities using tax audit services (https://www.patronaccounting.com/tax-audit), preparing the application with complete documentation and addressing potential objections proactively increases the likelihood of approval.
Five Conditions for Notification (Rule 7(5))
The Central Government must satisfy itself that all five conditions are met before issuing the notification:
| # | Condition | Detail |
|---|---|---|
| 1 | Bond tenure: 10-20 years | The zero coupon bond must have a maturity period of not less than 10 years and not more than 20 years from the date of issue. |
| 2 | Investment grade rating from 2 agencies | The issuing entity must have an investment grade credit rating from at least 2 credit rating agencies registered under Section 12(1A) of the SEBI Act, 1992. |
| 3 | Stock exchange listing | Necessary arrangement must be made for listing the ZCB on a recognised stock exchange in India before the notification is issued. |
| 4 | Fund deployment timeline | The entity must undertake to deploy: (a) at least 25% of the realisation before the end of the FY immediately following the year of issue; and (b) the balance within 4 FYs after the year of issue. |
| 5 | Sinking fund (infrastructure debt funds only) | An IDF must maintain a sinking fund for the accruing interest on all ZCBs subscribed. The sinking fund interest must be invested in Government Securities under the Government Securities Act, 2006. |
Post-Notification Compliance
The notification is not the end of compliance-ongoing obligations include:
- Annual CA certificate (Rule 7(8)): Within 2 months from the end of each FY referenced in the fund deployment undertaking (Condition 4), the entity must submit a certificate from a chartered accountant (as defined in Section 515(3)(b)) specifying the amount invested in each year. This is filed in the prescribed form.
- Power to withdraw notification (Rule 7(9)): If the entity fails to fulfil any of the conditions after notification, the Central Government has the power to withdraw the notification. Withdrawal means the ZCB loses its notified status-and with it, the special tax treatment.
- Credit rating maintenance: If the investment grade rating from either of the two agencies is withdrawn or expires, the notification may be withdrawn.
For entities using professional accounting services (https://www.patronaccounting.com/accounting-services), the annual CA certificate and ongoing compliance monitoring are specialised engagement areas that ensure the ZCB’s notified status is maintained throughout its 10-20 year life.
Tax Treatment: Issuer and Investor
For the Issuer
- Discount deduction (Section 36(1)(iiia)): The discount-the difference between the issue price and the maturity/redemption value-is deductible as a business expense on a pro-rata basis over the life of the bond. The pro-rata computation is done on a calendar-month basis (months of 15+ days are rounded up to one month).
- Example: A ZCB with face value Rs 1,000 issued at Rs 400 with a 15-year maturity has a discount of Rs 600. The annual pro-rata deduction is Rs 600 / 15 = Rs 40 per year.
- No TDS obligation: No TDS is deducted at source on any payment in respect of zero coupon bonds, per Section 194A(3)(x). This eliminates the administrative burden of TDS compliance for the issuer.
For the Investor
- Capital gains (not interest): Since ZCBs make no periodic interest payments, the entire return is treated as capital gains on transfer or maturity-not as interest income. This is a fundamental tax advantage.
- Holding period: ZCBs held for more than 12 months qualify as long-term capital assets. Under the old regime, LTCG was taxable at the lower of: (a) 20% with indexation, or (b) 10% without indexation. Under the IT Act, 2025, the rate depends on the specific provision applicable (12.5% for listed bonds under certain conditions).
- No annual tax obligation: Unlike regular bonds where interest is taxable annually on accrual or receipt, ZCB investors have no tax obligation until the bond is sold or redeemed. This provides significant tax deferral.
- No TDS on maturity/redemption: Section 194A(3)(x) exempts ZCBs from TDS, so the full maturity amount is received without withholding.
Old Framework vs New Framework
| Aspect | Old (IT Act 1961 / Rules 1962) | New (IT Act 2025 / Rules 2026) |
|---|---|---|
| Definition | Section 2(48) of IT Act 1961 | Section 2(112) of IT Act 2025 |
| Notification rule | Rule 2F (old Rule for ZCB notification), Form 5B | Rule 7, Form 2 (renumbered and consolidated) |
| Eligible entities | Infrastructure capital companies/funds, public sector companies, scheduled banks | Same + infrastructure debt funds explicitly included; scheduled banks not separately mentioned but may qualify as PSU/company |
| Tenure | 10-20 years | 10-20 years (unchanged) |
| Credit rating | Investment grade from 2 SEBI agencies | Investment grade from 2 SEBI agencies (unchanged) |
| Fund deployment | 25% in first FY, balance within 4 FYs | 25% in first FY, balance within 4 FYs (unchanged) |
| Issuer deduction | Section 36(1)(iiia) - pro-rata discount deduction | Carried forward under the 2025 Act (Section 32(d) for pro-rata discount computation) |
| Investor taxation | Capital gains; LTCG at lower of 20% indexed or 10% unindexed (proviso to Section 112(1)) | Capital gains; rate under 2025 Act (12.5% for specified listed bonds; specific provisions to be confirmed by final rules) |
| TDS | No TDS (Section 194A(3)(x)) | No TDS (carried forward) |
Common Mistakes to Avoid
Mistake 1: Applying less than 3 months before the proposed issue date. Rule 7(1) mandates a minimum 3-month lead time. Applications filed late will not be processed, delaying the entire issuance.
Mistake 2: Applying for bonds to be issued beyond 2 financial years. Rule 7(2) prohibits applications for bonds proposed to be issued beyond 2 FYs following the application year. Plan the issuance timeline accordingly.
Mistake 3: Not obtaining investment grade rating from 2 agencies before applying. The dual credit rating is a pre-condition for notification. Approaching only one agency or not having the rating ready at application time leads to rejection.
Mistake 4: Not filing the annual CA certificate within 2 months of FY end. Post-notification, the annual CA certificate confirming fund deployment is mandatory under Rule 7(8). Missing this deadline can lead to notification withdrawal.
Mistake 5: Investor treating ZCB returns as interest income. For investors, the return on notified ZCBs is taxed as capital gains, not interest. Reporting it under Income from Other Sources is incorrect and leads to higher tax liability.
Key Takeaways
Rule 7 of the Income Tax Rules, 2026 (notified 20 March 2026) provides a structured notification framework for zero coupon bonds issued by infrastructure capital companies, infrastructure capital/debt funds, and public sector companies. The application in Form 2 must be filed at least 3 months before the proposed issue date, with the Government disposing of it within 6 months.
Five conditions must be satisfied: 10-20 year tenure, investment grade rating from 2 SEBI agencies, stock exchange listing, phased fund deployment (25% in the first FY, balance within 4 FYs), and sinking fund maintenance (for IDFs). Post-notification, annual CA certificates and ongoing compliance are required, and the Government retains the power to withdraw the notification for non-compliance.
The tax treatment is favourable for both parties: issuers deduct the discount pro-rata over the bond’s life under Section 36(1)(iiia)/32(d), while investors pay capital gains tax only on sale or maturity with no TDS and no annual tax obligation. For India’s infrastructure financing ecosystem, notified ZCBs offer a unique combination of long-term capital, regulatory discipline, and tax efficiency.
Planning a Zero Coupon Bond Issuance?
ZCB notification requires careful planning: application timing (3 months advance), credit rating procurement (2 SEBI agencies), stock exchange listing arrangement, fund deployment undertaking, and post-notification annual compliance. The tax benefits are significant for both issuers and investors, but only notified bonds qualify.
Explore our income tax compliance services (https://www.patronaccounting.com/income-tax-return) for ZCB notification advisory, Form 2 preparation, annual CA certification, and infrastructure financing tax planning.
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