TMI BlogClarifications regarding tax treatment of deep discount bonds and STRIPS (Separate Trading of Registered Interest and Principal of Securities)X X X X Extracts X X X X X X X X Extracts X X X X ..... uch bonds will be treated as interest income assessable under the Income-tax Act. On transfer of the bonds before maturity, the difference between the sale consideration and the cost of acquisition would be taxed as income from capital gains where the bonds were held as investment, and as business income where the bonds were held as trading assets. On final redemption, however, no capital gains will arise. It was further clarified that tax would be deducted at source on the difference between the bid price and the redemption price at the time of maturity. 2. Such tax treatment of Deep Discount Bonds, however, has posed the following problems : (i) Taxing the entire income received from such a bond in the year of redemption as interes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to as the valuation date) and mark such bond to such market value in accordance with the guidelines issued by the Reserve Bank of India for valuation of investments. For this purpose, market values of different instruments declared by the Reserve Bank of India or by the Primary Dealers Association of India jointly with the Fixed Income Money Market and Derivatives Association of India may be referred to. 4.1 The difference between the market valuations as on two successive valuation dates will represent the accretion to the value of the bond during the relevant financial year and will be taxable as interest income (where the bonds are held as investments) or business income (where the bonds are held as trading assets). 4.2 In a c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ains. Redemption 6. Where the bond is redeemed by the original subscriber, the difference between the redemption price and the value as on the last valuation date immediately preceding the maturity date will be taxed as interest income in the case of investors, or business income in the case of traders. 6.1 Where the bond is redeemed by an intermediate purchaser, the difference between the redemption price and the cost of the bond to such purchaser will be taxable as interest or business income, as the case may be. For this purpose, again, the cost of the bond will mean the aggregate of the cost at which the bonds were acquired and the income arising from the bond which has already been offered to tax by the person redeeming the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tible at source on interest payable on Government securities. Further, the Central Government is empowered to specify any such bonds issued by an institution, authority, public sector company or co-operative society by way of notification, exempting them from the requirement of tax deduction at source. Option to investors 9. Considering the difficulties which might be faced by small non-corporate investors in determining market values under the RBI guidelines and computing income taxable in each year of holding, it has further been decided that such investors holding Deep Discount Bonds upto an aggregate face value of rupees one lakh may, at their option, continue to offer income for tax in accordance with the earlier clarifications ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... over the period of holding. Further, where the bond was redeemed by a person other than the original subscriber, such person was taxed on the entire difference between the bid price and the redemption price as interest income. Such a system also created tax-induced distortions in the debt market, and was an impediment to the development of a market in STRIPS, which are essentially zero coupon instruments derived from normal coupon bearing bonds. Taxation of income on accrual basis is an established principle of law, and always results in taxing income that has not yet been received. Income from deep discount bonds accrues continuously over the period of holding and can be realized at any time by selling the bond. Taxing income from such ..... X X X X Extracts X X X X X X X X Extracts X X X X
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