Domestic, foreign and Eurobonds, and how bonds are taxed

Where was the bond issued, and by whom?

Where a bond is issued and traded decides which legal, regulatory and tax rules apply to it. Three questions classify it: whose bond is it, where is it sold, and under whose rules.

Bonds by place of issuewhose bond, sold where, under whose rules

• Domestic bond Memorize local issuer, local market, local rules
• International bonds Use it anything other than domestic
  • Foreign bond Memorize outside issuer in a country's market, usually in its currency
  • Eurobond Memorize outside the jurisdiction of any single country; any currency
  • Global bond Memorize Eurobond market plus at least one domestic market, at once

Type	Who issues, where	Notes
Domestic	an issuer incorporated in the country, in that country’s market	most issuance
Foreign	an issuer from elsewhere, in another country’s market	matches funding currency to foreign operations
Eurobond	outside the jurisdiction of any single country, any currency	fewer listing, disclosure and regulatory rules; usually unsecured; underwritten internationally
Global	simultaneously in the Eurobond market and at least one domestic market	very large issues

Domestic bonds are issued in a country by an issuer incorporated there. Foreign bonds are issued by an outside issuer in that country’s market, normally in its currency and under its rules. Companies use them to match the currency of their funding with the currency of their foreign operations.

Eurobonds are issued outside the jurisdiction of any single country and may be denominated in any currency, including the issuer’s own. They are named for their currency (a Eurodollar or Euroyen bond, for example), are usually unsecured and are underwritten by a group of intermediaries from different countries. US dollar Eurobonds cannot be sold to US investors at issue, except to large qualified institutions, because they are not registered with the US regulator. The market began in the 1960s to avoid the legal, regulatory and tax limits of national markets.

Global bonds are issued simultaneously in the Eurobond market and in at least one domestic market, which gives very large issues, such as those of supranational banks, demand from investors everywhere. Foreign bonds, Eurobonds and global bonds together are international bonds .

Registered or bearer?

Bearer bonds kept no record of the owner: only the clearing system knew who held them. Today Eurobonds, domestic bonds and foreign bonds are all registered bonds , with ownership recorded by name or serial number.

What changes by market?

In frontier markets the local corporate bond market is small, so companies mostly borrow from banks, and investors reach corporates only through bank bonds. Governments and a few large issuers there borrow abroad in a major currency such as the dollar or the euro to reach more investors. Developed markets attract foreign issuers and investors seeking liquid markets in freely floating currencies.

A bond’s price depends more on its currency of denomination than on where it was issued. Market rates in that currency drive the yield. A yen bond from a Brazilian issuer is priced off yen rates.

Sukuk are Islamic-finance securities that pay no interest. Investors instead receive rental or profit payments from assets in which they have an ownership claim, and the structure avoids financing activities that Islamic law prohibits.

How are bonds taxed?

Issuers usually deduct interest, which lowers the after-tax cost of debt compared with equity (the corporate issuers topic returns to this).

Investors usually pay tax on coupons as ordinary income , the rate that applies to salary. Some bonds are exempt: US municipal bonds, for example, are often free of federal income tax. Some countries tax interest at source (net payment), while many Eurobonds pay gross, which leaves investors free to decide how and where they pay the tax.

Selling a bond above or below its cost creates a capital gain or loss. Capital gains tax often has its own rate, and some countries charge less on holdings kept longer than a year. Not every country taxes capital gains or separates short from long holdings.

Taxes on a bond investmentrules differ by country

• Coupon interest Memorize usually ordinary income, taxed as salary would be
• Capital gain or loss Use it sold above or below cost; often taxed differently, sometimes lower for long holdings
• Discount bond (OID) Memorize par minus issue price
  • With an OID provision Memorize a share of the discount is taxed as interest each year; no capital gains tax at maturity
  • Without one Memorize nothing until maturity; then the discount is a capital gain
• Premium bond Use it some countries let the premium be deducted over the life, or taken as a capital loss at redemption

What is original issue discount?

A bond issued below par has an original issue discount (OID): par minus the issue price. The discount is the interest on a zero-coupon bond, and countries treat it differently.

$$\text{OID} = \text{Par} - \text{Issue price}$$

Some countries also have a rule for bonds bought at a premium. The investor may deduct a share of the premium each year until maturity, or take no deduction and claim a capital loss when the bond is redeemed.

Exam tip Classify first: whose bond, sold where, under whose rules. Then tax: coupons are income, price gains are capital gains.

Go deeper Why the Eurobond market began

In the 1960s, issuers and investors wanted to avoid tight rules on borrowing and lending in national markets, especially in the United States. Dollar bonds sold outside the United States by non-US intermediaries escaped those rules, and a cross-border market grew from there. Lighter disclosure, and interest often paid gross, still distinguish it.

Go deeper Private placements alongside a Eurobond

An issuer can sell a Eurobond to investors in Europe, the Middle East and Asia and, at the same time, place part of it privately with large qualified institutional buyers in the United States. A sovereign issuer’s single bond can therefore be both a Eurobond and a private placement.

Go deeper Holding periods and capital gains

Rules for capital gains differ widely. Some countries tax them at a lower rate after a year or more, some treat short-term gains like salary, and some have no capital gains tax at all. In an exam question, use the rule the vignette gives you, and do not assume one.