Mr. X holds listed tax-free bonds of NABARD for 15 months and then redeems them at a price higher than his purchase price. As per NISM Series X-B Chapter 10, what is the tax treatment of the interest and the redemption gain?

[ A ]The interest is exempt under Section 10, but the long-term capital gain on redemption is taxable at 12.5%[ CORRECT ]

[ B ]Both the interest and the capital gain on redemption are exempt under Section 10

[ C ]The interest is taxable at normal slab rates, while the capital gain on redemption is exempt

[ D ]Both the interest and the capital gain on redemption are taxable at normal slab rates

Takeaway

Option A is correct: interest on tax-free bonds is exempt under Section 10, but capital gains arising on their transfer or redemption are chargeable to tax in the same manner as coupon bonds — here as a long-term capital gain taxed at 12.5% since the listed bond was held for more than 12 months.

Derivation

NISM X-B Section 10.2.3 clarifies that while tax-free bonds give tax-free interest income under Section 10, the capital gains on their transfer or redemption are taxable exactly like ordinary coupon bonds under Table 10.1 — 12.5% without indexation for listed bonds held beyond 12 months. A common error is assuming the 'tax-free' label extends to capital gains as well.

Why the others fail

B — Both the interest and the capital gain on redemption are exempt under Section 10

Section 10 exempts only the interest income from tax-free bonds; the capital gain arising on transfer or redemption of such bonds remains chargeable to tax like any other coupon bond.

C — The interest is taxable at normal slab rates, while the capital gain on redemption is exempt

This reverses the actual rule: interest on tax-free bonds is exempt under Section 10, while the resulting capital gain on redemption is taxable, not the other way around.

D — Both the interest and the capital gain on redemption are taxable at normal slab rates

Interest income on tax-free bonds is specifically exempt under Section 10; it is not taxable at slab rates as this option suggests.