Zero-coupon bond tax break withdrawal risks growth

The withdrawal of the income tax exemption on returns from zero-coupon bonds under the Finance Bill FY2026-27 sits uneasily with the country’s efforts to develop a vibrant corporate bond market. Introduced in 2008 and restored in 2020, the exemption was designed to attract investors to a market characterised by low liquidity and limited participation.

The decision comes at a time when Bangladesh remains heavily dependent on bank financing, with more than 90 percent of private sector credit supplied by banks. The corporate bond market remains extremely small, accounting for only around 0.01 percent of GDP, far below regional peers, according to Asian Development Bank Asian Bond Monitor data. The withdrawal may therefore reduce investor appetite and weaken momentum to develop an alternative source of long-term financing.

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Under the tax framework introduced in 2008, income earned from zero-coupon bonds was exempt from tax for all investors except banks, insurance companies and financial institutions, subject to approval from the primary regulator and the Bangladesh Securities and Exchange Commission (BSEC). The exemption was intended to compensate investors for the relatively higher risk and lower liquidity associated with long-term corporate debt and to encourage financing beyond traditional bank loans.

Unlike conventional bonds, zero-coupon bonds do not provide periodic interest payments. They are issued at a discount and redeemed at face value on maturity, with the difference representing the investor’s return. Because such instruments typically involve longer investment horizons and lower secondary market liquidity, many countries have used targeted tax incentives to improve their attractiveness, particularly in the early stages of bond market development.

Bangladesh’s financial sector remains heavily bank-centric, with limited contribution from capital and corporate bond markets. In contrast, more developed Asian economies have built deep corporate debt markets that complement bank lending. South Korea’s corporate bond market, for example, accounts for about 80 percent of GDP. Expanding Bangladesh’s corporate bond market would help diversify financing sources, support long-term investment, reduce maturity mismatches and broaden investment opportunities.

The removal of the ZCB tax exemption may reduce investor demand by lowering post-tax returns. Assuming a 15 percent tax rate, an investor earning a 12 percent annual return from a zero-coupon bond would effectively receive about 10.2 percent after tax unless the issuer raises the yield. To maintain the same after-tax return, the issuer would need to offer a yield of roughly 14.1 percent, increasing borrowing costs.

Higher financing costs may discourage companies from issuing bonds and push them back towards bank loans. This would further increase dependence on the banking sector and slow the development of alternative long-term financing channels.

While removing the exemption may marginally expand the government’s tax base, revenue from zero-coupon bonds is currently insignificant because issuance remains limited. Regulators and market experts have repeatedly stressed the need for fiscal incentives to support Bangladesh’s underdeveloped bond market. During discussions on the FY2020 budget, BSEC advocated not only restoring the ZCB tax exemption but also extending similar incentives to other debt instruments.

International experience suggests that successful bond market development requires fiscal support alongside effective regulation and market infrastructure. Malaysia combined tax incentives with regulatory reforms, stronger disclosure standards, domestic credit rating agencies and efficient trading systems, helping its bond market grow to more than 100 percent of GDP. India has also adopted a streamlined regulatory framework that facilitates corporate bond issuance.

Given that Bangladesh’s corporate bond market remains negligible compared with regional peers, withdrawing a key incentive at this stage may weaken investor appetite, raise the cost of capital and slow the country’s ambition to build a diversified bond market. Reconsidering the policy could benefit investors, businesses and the broader economy.

The writer is the managing director of IDLC Investments Limited