The Hindu Business Line : Demons in the bond regime

AFTER a great deal of vacillation, the Central Board of Direct Taxes (CBDT) has at last crystallised its stand on tax treatment of deep discount bonds (DDB). Hitherto, neither investors therein nor dealers thereof have lost sleep over tax liability thereon, drawing solace from the Keynesian philosophy that in the long run we are all dead. Yes, the CBDT had reconciled itself to collecting tax only on redemption of DDBs which is normally a distant event given the fact that typically these bonds become redeemable after 25-50 years. And such tax would have been on interest. But a wily investor would in such a regime have disposed of the bonds before maturity so that he could have benefited from a still more benevolent regime — capital gains tax. To be sure, such capital gains would have been of the long-term variety that is handled with kid gloves — a slew of tax shelters thrown in or a soft flat rate of tax if one is not in a position or inclined to use these shelters.

The new regime

The new regime enshrined in CBDT circular 2/2002 of February 15, 2002, has the following salient features:

DDBs will have to be marked to market on March 31 of each year. For this purpose, assessees will have to consider appropriate benchmark quotations made available by the RBI and other recognised agencies;

The accretion between two valuation dates shall be taxable as interest or business income according as the assessee is an investor or a dealer;

Should the assessee acquire the DDB during the course of a financial year, the difference between the market value (as on the immediately following March 31) and the acquisition price would be the interest income or, as the case may be, the business income;

Should the DDBs be transferred before maturity, the tax liability would be on capital gains for investors and on business income for dealers. And in either case, it would be represented by the difference between sale price and the cost of acquisition as increased by income already taxed over the years when the assessee held the bonds. Since effectively only the accretion during the intervening period between two valuation dates is taxed, the capital gains will be of the short-term variety; and

On maturity, there would not be any bunching effect as hitherto because the gains over the years would have been captured into the tax net then and there without allowing them to snowball.

The glitches

The scheme of advance tax should be amended to exempt income from DDBs, except by way of capital gains from its purview because nobody can possibly pay advance tax on an income that is going to crystallise only on the last day of the year;

The CBDT circular says that the new regime comes into effect hereafter. Yet, it has not made any transitional provisions. There are DDBs issued long ago which may be midstream. Will the entire accretion over the years be taxed as per the new regime in one go in the assessment year 2002-2003?

What if instead of there being an accretion, the bottom-line is a depletion? Will in that case be one assessed for negative interest? A negative income is common for one in business. But can an investor claim the negative interest for set-off? Will in that event, for computing capital gains, such loss be deducted from the actual cost of acquisition on the ground that the assessee has already derived some tax advantage from such loss?

By mistake, paragraph 8 of the circular says that "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... " How can one deduct tax on income that has already been subjected to tax over the years? It is precisely to eschew the bunching effect that the new regime contemplates tax on annual accretion. In the event, the scheme of TDS would have no relevance both during the currency of DDB as well as on its maturity in the scheme of new things; and

Small investors in DDBs — holding up to a face value of Rs 1 lakh — will have to, even under the new regime, opt for the old regime — pay tax only on maturity. This has been done so that they are not subjected to difficulties in ascertaining on each March 31, the market value under the RBI guidelines on marking securities to market.

It is submitted that this option should be available only to initial subscribers. If it is made available to market purchasers, there could be utter confusion all-round, engendered by the fact that their predecessor(s) might or might not have made use of this option.

Once the regime is rid of these and other glitches that may come to light, it is bound to be at once equitable and workable.

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