The Hindu Business Line : Income on deep discount bonds to be taxed yearly

RETAIL investors, financial institutions and banks holding deep discount bonds have cause for cheer. The Finance Ministry has completely modified the tax treatment on income accruing from these bonds by shifting the entire tax burden at the time of redemption to a system of yearly payments.

As a result, bond-holders will not be subjected to a huge tax liability at redemption time since interest income will be taxed yearly.

This is in contrast to the earlier system where the holder of a deep discount bond of, say, a 20-year maturity had to fork out tax on the entire income in the year of redemption. Besides imposing a hefty tax liability, taxing the entire income only at the time of maturity amounted to a tax deferral.

Small non-corporate investors holding deep discount bonds of an aggregate face value of up to Rs 1 lakh have, however, been given the option to continue paying tax as per the earlier system.

Bankers reckon that the flexibility will help retail investors claim tax deductions (under Section 80 L of the Income-Tax Act) on interest income. Alternatively, the holder can also transfer the bonds before maturity and pay the concessional 10 per cent long-term capital gains tax. However, such an option has not been extended to investors holding deep discount bonds with a face value of over Rs 1 lakh. According to officials, the same tax rate will apply on all income since transfer of these bonds prior to maturity will now be treated as short-term capital gains.

Each person holding a deep discount bond will henceforth be required to make a market valuation of the bond at the end of each financial year and mark such bond to market values of different instruments declared by the RBI or by the Primary Dealers' Association of India jointly with the Fixed Income Money Market and Derivatives Association of India.

The difference between market valuations on two successive valuation dates will represent the accretion to the value of the bond in the relevant financial year. This will be taxable as interest income where bonds are held as investments or business income where bonds are held as trading assets, according to the CBDT.

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