Section 8: Bondholders
8.4. Selling or redeeming bonds
8.1. Tax and bonds
Interest from bonds is taxable in the same way as other interest income. However, capital gains and capital losses on bonds do not, as a rule, have any effect on tax. There is no allowance for any costs incurred with the custody account and in general transaction costs are not deductible either.
8.2. Buying bonds
A bond is a debt security. When you buy a bond, it is the equivalent of a loan to the bond issuer. The bond issuer is obliged to pay a certain rate of interest at certain times to the buyer. The issuer is also obliged to repay “the loan” to the buyer. This repayment is either made at a certain time or with instalments over a longer period.
Differences in bonds
There are various forms of bonds. The most usual are government bonds and mortgage bonds. There may be different series within the different types of bonds, with differing maturities and interest rates.
Furthermore, there may be a difference regarding whether or not the bonds are callable. A callable bond means that the issuer may redeem it prior to the stated maturity date. A non-callable bond cannot be redeemed with exceptional payments or premature repayments in cash, but only with other bonds.
The repayment profiles of bonds can also vary. For bullet loans, the entire bond amount is repaid at maturity while interest payments are made regularly. This also applies to some treasury notes and government bonds. It is also possible to take out an interest only mortgage.
Serial loans are repaid with equal amounts at each due date but the interest means that the total amount is larger at the start of the period and decreases towards the end.
Annuity loans have small repayments at the start that increase in size towards the end of the loan period. However, the total repayment including interest is equal throughout the entire period. Most mortgage bonds are settled according to this principle.
8.3. Owning bonds
Tax on interest from bonds
For private investors, interest on bonds is taxed as capital income in the same way as any other interest income.
The interest received over the course of the year is included on the income tax return.
For example, if the interest on a bond is due on 2nd January and 1st July, the accumulated interest should be included on the 2007 income tax return.
If the bond is sold on the 10th March 2007, the interest received on the 2rd January should be included on the 2007 income tax return. Furthermore, interest for the period from the 2rd January until the 10th March must also be included. As no interest is paid on the bond before the 1st July, it is typically the buyer of the bond who pays the seller for the loss in interest revenue.
This amount is called accrued interest. In return for this amount, the buyer is entitled to receive the entire interest at the next payment date, in this example the 1st July. If the sale takes place close to the interest payment date, in practice it is the seller who receives the interest and the seller pays the buyer for his or her part of it.
Tax is paid on the accrued interest or it is deducted for the year in which the transaction takes place. This also applies even if the interest on the bond for which payment has been made or received is not due for another year.
8.4. Selling or redeeming bonds
Tax on capital gains /losses
In the vast majority of cases a private investor who invests his or her savings in bonds will not pay tax on profits caused by a price increase of bonds. But neither can any losses be deducted.
Whether or not a person has to pay tax on capital gains in connection with the sale or redemption of a bond depends on whether the bond meets the requirements for the minimum coupon rate.
Minimum coupon rate
The minimum coupon rate is an interest rate that is set for 6 months at a time a few days before the start of the applicable period. The minimum coupon rate is calculated based on market interest according to certain guidelines and is published in the price book value list and in the Danish Official Gazette.
At the time the bond is issued, the minimum coupon rate requirement must be met. Any later changes in interest are insignificant, even if the bond is sold on to a new owner. For the period from 1st January to 30th June 2008, the minimum coupon rate is 4 %.
“Blue-stamped” bonds
If the requirement for the minimum coupon rate is met at the time the bond is issued, it is called a blue-stamped bond. This blue-stamping means that any capital gains on sale or redemption is tax free for private investors. As previously mentioned, private investors in bonds will typically only deal in blue-stamped bonds.
“Black-stamped” bonds
If the bond does not meet the minimum coupon rate when it is issued, the bond is black stamped. This means that any capital gains are taxable for the bond owner and for any later buyers of the black-stamped bond. Despite this tax liability, any losses cannot be deducted if the bond owner makes a capital gain.
Special situations
In some situations, capital gains are taxed, even if the bond meets the minimum coupon rate and is blue-stamped.
This applies firstly if the bond is bought with borrowed funds.
This is the case if the investor has taken out a large loan in connection with the purchase of the bond or if there is a clear connection between the loan and the bond purchase.
In this situation, capital loss cannot be deducted.
Another exception to the main rule of private taxpayers’ tax-free capital gains on blue-stamped bonds is foreign currency bonds.
For example, if a bond is issued in Euro or US dollars, the capital gains are taxable. At the same time, it is possible in most cases to deduct any capital loss.