Decoding Taxability With Deep Discount Bonds

MCQ SELF CHALLENGE # 0066 ON TAXABILITY IN CASE OF DEEP DISCOUNT BONDS

Taxability in the Case of Deep Discount Bonds

Dear Professional Seniors & Friends.

Warm Greeting!

Here is the Next post of #MCQ on concept-based practical professional knowledge on Taxability in the case of deep discount bonds under the income tax act in a unique manner to be self-answered by participants. The detailed answers to these MCQs shall be posted the next day for the self-assessment of the participants. DSRV India - The best chartered accountant firm in India, urges you to read this blog on deep discount bonds and taxability here.

MCQ 66.1: Mr. X an investor. purchase a deep discount bond having a face value of Rs 1.5 Lakhs on 01.02.2017. The market value of the bond on 31.03.2017 is Rs 2.5 lakhs. On 20.03.2018 (redemption date of deep discount bond), Mr. X got the redemption price of Rs 4,5 lakhs. What will be the tax effect on the date of redemption?

A) Rs 3 lakhs shall be capital gain income.

B) Rs 2 lakhs shall be capital gain income.

C) Rs 3 lakhs shall be interest income.

D) Rs 2 lakhs shall be interest income.

MCQ 66.2: What if in the above question? Mr. X before the date of redemption, sold the deep discount bonds on 31.10.2017 for Rs 6 lakhs.

A) Rs 4.5 lakhs shall be capital gain income.

B) Rs 3.5 lakhs shall be capital gain income.

C) Rs 4.5 lakhs shall be interest income.

D) Rs 3.5 lakhs shall be interest income.

Answer MCQ Self Challenge #0066

This post of MCQ is on the concept relating to the taxability of deep discount bonds in both cases where these are redeemed or where these are sold before the date of redemption.

Answer to MCQ 66.1: D) Rs 2 lakhs shall be interest income.

Answer to MCQ 66.2: B) Rs 3.5 lakhs shall be capital gain income.

Practical Analysis for MCQ 66.1&66.2:-

1. Upto 15/02/2002, 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.

2. The matter has then been examined in consultation with the Reserve Bank of India and the Ministry of Law. The Board then vide circular no 2/2002 dated 15/02/2002 have decided that such income may hereafter be treated as follows-

General treatment

3. Every person holding a Deep Discount Bond will make a market valuation of the bond on the 31st March of each Financial Year and mark such bond to such market value

4. The difference between the market valuations 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)

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 up to the date of transfer.

6. 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 a period would always be less than one year, the capital gains will be chargeable to tax as short-term capital gains.

Redemption

7. 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 taxable as interest income in the case of investors, or business income in the case of traders.

8. So in our case. Rs 1 lakhs(2.5-1.5) shall be taxed as interest income in FY 2016-17, hence the cost of the bond will become Rs 2.5 Lakhs(1,5+1)

9. Based on the above analysis, correct answer MCQ 1: D) Rs 2 lakhs shall be interest income

10. Correct answer MCQ 66.2 B) Rs 3.5 lakhs shall be capital gain income.

(Disclaimer: The objective of the MCQ post is just to discuss the concept. it may happen, by change of facts, the answer may be different. Please do not treat this as a professional opinion: you can definitely have your own opinion.)

Sincere Regards!

CA Sanjay Kumar Agrawal

Mobile: 9810116321