When a bond is bought between interest payment dates, the buyer compensates the seller for the interest they have earned up to that point. This is known as accrued interest. It is calculated from the last coupon date up to the settlement date of the transaction and is added to the bond’s price at the time of purchase. 

Then, on the next interest payment date, the full coupon is paid to the bondholder on record, in this case, the buyer. However, the full amount of that interest payment is also subject to withholding tax, in line with local regulations. 

What this means in practical terms is: You pay the seller accrued interest when purchasing the bond You receive the full interest payment on the coupon date You are taxed on the full coupon amount, including the portion that reflects interest accrued before you owned the bond.

This occurs because tax is applied to whoever is holding the bond at the time the interest is paid, regardless of how long they’ve held it. Unfortunately, the tax system does not account for the fact that part of the interest was effectively passed on to you from the seller. There is currently no mechanism to offset or reclaim the tax on the portion of interest you paid to the previous holder. 

While this is a standard and widely accepted approach in fixed income markets, we understand it may seem counterintuitive. If you are investing in bonds frequently or in larger amounts, it may be helpful to take this into consideration when assessing expected returns, particularly if you are buying close to an upcoming coupon date.