06 July 2012
Some of the companies have issued different types of NCDs/Bonds which are listed on stock exchanges as follows 1)Zero Coupon Bond payable after say 2&half years e.g. IIFL 2)Zero coupon Double Money Bond payable after 6&half years e.g.Shriram Transport Finance 3)Deep Discount Bonds payable after 5 years e.g.Manappuram If We do not take interest on accrual basis every year in respect of all the above categories & sell it before maturity & pay Capital Gains tax on indexation basis,will it be in order? Experts please advise. Pankaj Ajmera
07 July 2012
if i presumed that in all the above case you have hold such bonds for a period more than 12months then you have option as to pay tax lower of the following i. @20% with indexation ii. @10% without indexation you will pay tax at the rate which ever is lower of the above but if holding is less than 12 months it is Short term and it will be taxable at normal rate or since it is listed and if STT is applicable it will be taxable @ 10%
09 July 2012
Sub : Taxability of certain types of listed ncds/bonds Thanks for the above clarification. However off lat my attention has been drawn to the CBDT circular No. 2/2002 dated. 15/02/2012. wherein it has been clarified by CBDT that in case when the amount invested in bonds is more then Rs. 1 lacs, in is mandatory on the part of assesses to disclose the income every year on accrued basis & benefit of long term capital gain will not be available. In view of clarification given above, the reply given by Mr.CA Sourabh Sethia seem to be in correct. Experts please advice
09 July 2012
Income from Deep Discount Bonds - The difference between the issue price and the redemption price of Deep Discount Bonds will be treated as interest income assessable under the Income-tax Act. On transfer of Bonds before maturity, the difference between the sale consideration and issue price will be treated as Capital Gains/Loss if the assessee purchased them by way of investment. However, in the case of an assessee who deals in purchase and sale of Bonds, Securities, etc., the profit or loss shall be treated as trading profit or loss - Letter [F. No. 225/45/96-IT(A-II)], dated 12-3-1996 of IDBI.
Tax treatment of deep discount bonds and STRIPS - A review of the tax treatment of income arising from Deep Discount Bonds has been under consideration in the Board for some time. The Board had earlier clarified by way of certain letters issued to the Reserve Bank of India and others that the difference between the bid price (subscription price) and the redemption price (face value) of such 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 interest income gives rise to a sudden and huge tax liability in one year whereas the value of the bond has been progressively increasing over the period of holding. (ii) Where the bond is redeemed by a person other than the original subscriber, such person becomes taxable on the entire difference between the bid price and the redemption price as interest income, since he is not able to deduct his cost of acquisition from such income. (iii) A company issuing such bonds and following the mercantile system of accounting may evolve a system for accounting of annual accrual of the liability in respect of such a bond and claim a deduction in its assessment for each year even though the corresponding income in the hands of the investor would be taxed only at the time of maturity. (iv) Taxing the entire income only at the time of maturity amounts to a tax deferral.
3. The matter has now been examined in consultation with the Reserve Bank of India and the Ministry of Law. The practice followed in several countries outside India has also been examined. With a view to remove the anomalies in the existing system of taxation of income from Deep Discount Bonds, and to formulate a system which is more in line with international practice, the Board have decided that such income may hereafter be treated as follows.
General Treatment
4. Every person holding a Deep Discount Bond will make a market valuation of the bond as on the 31st March of each Financial Year (hereafter referred to as the valuation date) and mark such bond to such market value in accordance with the guidelines issued by 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 case where the bond is acquired during the year by an intermediate purchaser (a person who has acquired the bond by purchase during the term of the bond and not as original subscription) the difference between the market value as on the valuation date and the cost for which he acquired the bond, will be taxed as interest income or business income, as the case may be, and no capital gains will arise as there would be no transfer of the bond on the valuation date.
Transfer before maturity
5. Where the bond is transferred at any time before the maturity date, the difference between the sale price and the cost of the bond will be taxable as capital gains in the hands of an investor or as business income in the hands of a trader. For computing such gains, the cost of the bond will be taken to be the aggregate of the cost for which the bond was acquired by the transferor and the income, if any, already offered to tax by such transferor (in accordance with para 4 above) upto the date of transfer.
5.1 Since the income chargeable in this case is only the accretion to the value of the bond over a specific period, for the purposes of computing capital gains, the period of holding in such cases will be reckoned from the date of purchase/subscription, or the last valuation date in respect of which the transferor has offered income to tax, whichever is later. Since such period would always be less than one year, the capital gains will be chargeable to tax as short-term capital gains.
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 bond.
Strips
7. Apart from original issue of Deep Discount Bonds, such bonds can also be created by “stripping”, i.e. the process of detaching the interest coupons from a normal coupon bearing bond and treating the different coupons and the stripped bond as separate instruments or securities (“strips”) capable of being traded in independently. Such a mechanism, referred to as STRIPS (Separate Trading of Registered Interest and Principal of Securities) creates instruments which are in the nature of Deep Discount or Zero Coupon Bonds from out of the normal interest bearing bonds. Accordingly, the tax treatment of the different components of principal and interest created by such stripping will be on the same lines as clarified in the preceding paragraphs in respect of Deep Discount Bonds.
7.1 The process of stripping of a normal interest-bearing bond into its various components will not amount to a transfer within the meaning of the Income-tax Act as it merely involves the conversion of the unstripped bond into the corresponding series of STRIPS. Similarly, the reconstitution of STRIPS to form a coupon bearing bond will not amount to a transfer.
Tax deduction at source
8. The difference between the bid price of a deep discount bond and its redemption price, which is actually paid at the time of maturity, will continue to be subject to tax deduction at source under section 193 of the Income-tax Act. Under the existing provisions of that section, no tax is deductible 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 issued by the Board referred to in para I above - Circular No. 2/2002, dated 15-2-2002.
Clarification one
There have been certain reports in the press recently, suggesting that the tax treatment of deep discount bonds as specified in the Circular dated February 15, 2002 issued by the Central Board of Direct Taxes is anomalous, as it provides for taxation of income from such bonds on an annual basis, even though no income is received by the bond-holder before maturity. It has been opined that a heavy tax burden is being placed on persons who have been holding such bonds for a while, and a cumbersome obligation of valuing the bonds every year on the basis of RBI guidelines is being cast on small investors. The reports are mis-conceived and based on an incorrect understanding and inadequate knowledge of facts and law. The modified tax treatment now specified in fact corrects the anomalies in the existing system by providing a mechanism for taxing income accruing from year to year on deep discount bonds, on the same lines as income from normal coupon bearing bonds is taxed. Transfer of the bonds before maturity will attract capital gains tax, as in the existing system.
The earlier system of taxing the entire income received from such bonds in the year of redemption as interest income was anomalous in that it gave rise to a sudden and huge tax liability in one year whereas the value of the bond had been progressively increasing 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 holding and can be realised at any time by selling the bond. Taxing income from such bonds on accrual basis annually is, in fact, a practice followed world-wide.
It is also an established principle that a circular issued by CBDT cannot have a retrospective tax effect. The present circular on deep discount bonds, therefore, specifies the tax treatment in respect of bonds which are issued after the issue of the circular, and does not seek to impose the modified treatment on existing bond-holders. Further, non-corporate persons who invest small amounts in new issues (face value upto Rs. 1 lakh) can still opt for the old system.
Valuing the bonds every year on the basis of RBI guidelines will not pose any problem as such values can be obtained from the issuers themselves, who will invariably be the RBI or a public financial institution.
The amount received on redemption would always be liable to tax deduction at source as per normal provisions of the Income-tax Act. However, no TDS is required on interest payable on Government securities, and bonds issued by an institution, authority, public sector company or co-operative society can also be exempted from the requirement by notification - Press release, dated 20-3-2002.
TDS on income from Deep Discount Bonds - See section 193 - Circular : No. 4/2004, dated 13-5-2004.
221B. Tax deduction at Source on income from Deep Discount Bonds
The tax-treatment of income from Deep Discount Bonds has been explained in the Board’s Circular No. 2/2002, dated 15-2-2002. Subsequently, the Board have received various requests for a clarification regarding tax deduction at source under section 193 of the Income-tax Act from interest on Deep Discount Bonds. Difficulties could also be faced by the taxpayers in view of section 199 of the Income-tax Act, which provides that credit for tax deduction at source shall be allowed only in the year in which the corresponding income is declared.
It is hereby clarified that tax is required to be deducted at source under section 193 or section 195, as the case may be, only at the time of redemption of such bonds, irrespective of whether the income from the bonds has been declared by the bond-holder on accrual basis from year to year or is declared only in the year of redemption.
It is further clarified that a person, who has declared the income from a Deep Discount Bond on annual accrual basis during the term of the bond, will be entitled to make an application under section 197 of the Income-tax Act, requesting the Assessing Officer to issue a certificate for no deduction of tax or deduction at a lower rate. In such a case, the assessee should furnish, along with the prescribed Form No. 13, details of the income offered for tax by him from year to year. In case the assessee is not the original subscriber, and has acquired the bonds from some other person, he shall furnish the relevant particulars including the name, address and PAN, of such other person. If the Assessing Officer is satisfied that the applicant assessee has declared his income from the bonds from year to year on accrual basis during the period the bond was held by him, he shall issue a certificate allowing the tax deduction at source at such reduced rate as is justified by the total income of the applicant in the year of redemption.
Similarly, an assessee being a resident individual, who is the original subscriber of a Deep Discount Bond, may furnish a declaration in Form No. 15H in accordance with section 197A, if he has been declaring income on the bond from year to year on accrual basis, and no tax is payable on his total income, including the interest.
Accruing during that year, in the year of redemption. However, such a declaration cannot be filed by an individual, other than a senior citizen availing tax rebate under section 88 B of the Income-tax Act, if the amount of accumulated interest, being paid on redemption, exceeds the maximum amount not chargeable to tax in his case. Circular No. 4/2004, dated 13-5-2004.
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