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The central board of direct taxes (CBDT) recently issued a circular
wherein it was stated that the income on deep discount bonds will be
taxed on an annual basis. Which means, the interest income accrued
every year will be considered as deemed income. Earlier, the practice
was to tax the income on redemption.
This
new system is going to have a harmful effect on the bondholder. How?
A deep discount bond is
basically a bond issued for long tenures, say 15, 20 or 25 years.
Suppose a deep discount bond for Rs 1 lakh is issued at 8 per cent for
a period of 20 years, the bondholder has to today pay Rs 20,000, and
after 20 years he will receive Rs 1 lakh. So, the interest income will
be Rs 80,000, and if the tax rate is 30 per cent the bondholder will
have to pay Rs 24,000 as tax. Thus, effectively, the post-tax return
on the bond will be 5 per cent.
Under the new dispensation,
tax will have to be paid annually. For the abovementioned bond, the
deemed income every year will be Rs 1,600, out of which the bondholder
will be taxed Rs 480. The post-tax return on the bond will drop from 5
per cent to 3.64 per cent - a drop of 27 per cent. All this at a
single stroke of the pen.
The circular is not clear on
whether the tax will be deducted by the bond-issuer (financial
institutions, banks). Or whether the amount has to be paid by the
bondholder. In the case of bank fixed deposits, under the cumulative
scheme the tax is presently deducted by the bank or the FI and sent
directly to the income-tax department.
Says M Bhandari, a senior banker: In this case, too, the issuer of
the bond should be asked to deduct and pay. ICICI officials are
also of the same view. In case the bondholder has to pay, then the
post-tax return on the bond under consideration will fall from 5 to
3.16 per cent - a drop of 37 per cent.
Says Vinod Gupta, a
practicing tax-consultant: The circular is in bad taste, and it can
be challenged. It is an accepted principle of law that CBDT circulars
cannot go against the interest of the assessee.
The new provision will affect
the investor heavily, as he has to adjust his
tax portfolio midway. The bond market will also be affected severely
because such bonds will no longer be attractive.
The only saving grace under the new provision is that bonds having a
face-value of up to Rs 1 lakh are exempted from this form of taxation.
But this is just a minor relief to the small investor.
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