Taxation of bonds in plain language: government, corporate and crown bonds

Bonds are a popular investment instrument, offering a more stable and predictable return than equities. For many people, they are an attractive way to save their money and earn a regular income in the form of interest. However, with investing comes the obligation to tax the returns properly. It is the question of how the taxation of bonds works that often confuses investors.

Some returns are taxed automatically by way of withholding tax, while others must be reported on the tax return. It also depends on whether the bond is a government, corporate or foreign bond and, last but not least, whether the investor meets the so-called time test when selling.

General principles of taxation of bond proceeds

Under Czech law, any proceeds from a bond are treated as income from capital assets. This means that it falls under the regime of the Income Tax Act and must be taken into account when making a tax return to the tax authorities. In practice, the way it works is that if you earn interest on the bond, or if you sell the bond at a profit, you have to tax this income.

The standard rate of tax is 15%, which is the same rate that applies to dividends, for example. However, in some cases, the tax is taken directly at the time of payment, which means the investor has nothing further to worry about. This is called withholding tax and is quite common. However, if withholding tax is not applied, it remains the investor’s responsibility to declare the income on the tax return. This is the difference between, for example, domestic and foreign bonds, as well as bonds traded on a regulated market and those issued by private companies to a limited number of investors.

Withholding tax on bond interest makes everything easier

The most common form of taxation is withholding tax on bond interest. It works by having the issuer, i.e. the bond issuer, or the bank that pays the yield, automatically deduct 15% of the interest credited and remit this amount to the state. The investor thus receives the net proceeds and does not have to declare them again in the tax return.

This system has the advantage of simplicity – the taxes sort themselves out and you can concentrate on the investment decision. Withholding tax typically applies to government bonds or large exchange-traded issues. For corporate bonds, the situation can be more complicated, as some companies pay out returns in a form that does not include withholding tax. In this case, the investor must calculate and declare the tax himself.

Taxation of government bonds is the simplest

Taxation of government bonds is the easiest for investors because withholding tax is almost always applied. So if you buy a Czech government bond, for example a 10-year fixed income bond, you will receive the amount less tax each time you pay interest. You don’t have to worry about anything else and you don’t have to declare the income anywhere.

In the past, however, the state also issued special savings bonds, for which the tax rules were different. Some were completely tax-free, others were subject to special treatment. These products are no longer currently offered, but some investors still hold them and must follow the rules applicable to the specific issue.

Crown bonds have special taxation

Crown bonds are a separate chapter. These are bonds issued in denominations of one koruna. This type of bonds was very widespread in the Czech Republic in the past because it allowed legal tax optimisation. The interest was calculated in pennies, but when rounded up to whole crowns for payment, it was already calculated in such a way that there was effectively nothing to tax. This led to a massive use of crown bonds, especially by companies and their owners, who paid out funds in this way with almost no tax burden.

Since 2013, this loophole has been closed and new crown bonds no longer have this benefit. Nevertheless, many of them remained in circulation because issues made before this date were not affected by the change. Therefore, the taxation of crown bonds is now double – old issues have a special regime, while new ones are subject to the standard tax rules. This is why crown bonds are often discussed in the media and among investors and why the tax authorities focus on them during audits.

What if I sell the bond?

Bonds don’t just earn interest, they also give you a profit when you sell them. If an investor buys a bond at a certain price and later sells it at a higher price, he will earn a capital gain. This gain is taxable, but the law also provides for a so-called time test.

If the investor holds the bond for more than three years, the gain on the sale is tax-free. This encourages investors to hold for longer and also simplifies administration. However, if you sell the bond earlier, you must report the gain on your tax return and tax it at 15 per cent. At the same time, the time test only applies to individuals, not corporations.

In practice, this can mean that short-term speculation on a bond’s price change is less profitable than long-term investing. The time test therefore plays an important role in investment strategies and should be borne in mind when making a purchase.

How foreign bonds are taxed

Many investors today also buy foreign bonds, whether they are German, US or other securities. In this case, double taxation often applies – once in the country of the issuer and the second time in the Czech Republic. To avoid the investor paying tax twice, there are international double taxation treaties. These usually allow tax paid abroad to be offset against Czech tax liability. However, it is necessary to prove that the tax was actually paid abroad, for example by a bank certificate. The taxation of foreign bonds is therefore administratively more demanding and it is worth monitoring what agreements the Czech Republic has with a particular country.

What is often wrong

A very common mistake is the assumption that if an investor receives the proceeds in his account, everything is always settled. But this may not be true. This is indeed true for Czech government bonds because withholding tax is automatically deducted. However, if you buy a corporate bond, especially a smaller issue, the proceeds may arrive untaxed and you may be obliged to declare them on your return.

Similarly, you need to think about bond sales over shorter time horizons than three years, where investors often forget about the time test. Another complication is crown bonds, which are watched very closely by the tax authorities, and foreign investments, where ignorance of double taxation rules can make them more expensive.

The taxation of bond proceeds is a topic that every investor should be familiar with, whether they are a small-time saver in government bonds or an experienced trader in corporate issues. Knowing the rules will not only help you meet your tax obligations correctly, but also help you plan your investments better. The correct taxation affects the net return and therefore the overall profitability of the investment. If you are unsure whether you have everything in order, we recommend you consult a professional.

Summary

The taxation of bonds in the Czech Republic is governed by the Income Tax Act and is a topic that fundamentally affects the final return on investment for investors. Interest on bonds is generally subject to a 15% withholding tax, which is paid directly by the issuer and is not recognised by the investor. The exception may be some corporate or foreign bonds where the tax is not withheld and the yield must be reported on the tax return. The taxation of government bonds is usually the simplest, as withholding tax is automatically applied, while crown bonds issued before 2012 have a special regime that in the past allowed virtually zero taxation and are still under scrutiny by the tax authorities. When selling a bond, you need to think about the three-year time test, the fulfilment of which means the profit is tax-free, otherwise the 15% rate applies here as well. Foreign bonds then carry the risk of double taxation, which can be addressed through international treaties.