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What are the tax implications on Deep Discount Bonds (DDBs)?

The tax treatment of DDBs will be in accordance with and subject to the conditions in the CBDT clarification F. No. 149/235/2001-TPL dated February 15, 2002 which are given in brief as under:
(a) Every bondholder will have to offer to tax the difference between the market valuation made in accordance with the guidelines issued by RBI as on two successive valuation dates (i.e. March 31 each financial year) as interest income (where the bonds are held as investment) or business income (where the bonds are held as trading asset). For this purpose, 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 may be referred to. In a case where the bond is acquired during the year, the difference between the market value as on the valuation date and the acquisition cost, will be taxed as income.

(b) On transfer of bond before maturity, the difference between the sale price and the cost will be taxable as short-term capital gains or business income, as the case may be. For computing such gains, the cost of the bonds will be taken to be the cost of acquisition plus the income offered to tax in the earlier years as explained in clause (a) above.

(c) In case of redemption, the difference between the redemption price and the value as on the last valuation date immediately preceding the maturity date will be taxed as income.
In case of an intermediate purchaser, the difference between the redemption price and cost of bond will be taxable as income. For this purposes, the cost of the bond will be taken to be the cost of acquisition plus the income offered to tax in the earlier years as explained in clause (a) above.

(d) A non-corporate investor holding DDBs upto an aggregate face value of Rs.1 lakh may opt to offer income for tax in accordance with earlier CBDT clarification dated March 12, 1996. The clarification states that the difference between the redemption price and subscription price would be treated as interest income assessable under the Income-tax Act in the year of maturity. It further states that on transfer of bonds before maturity, the difference between the sale price and issue price will be treated as capital loss/gains if held by the assessee as investments or as trading profit/loss if the assessee dealt in purchase of sale of bonds, securities, etc.

(e) The difference between the issue price and redemption price will be subject to tax deduction at source under section 193 of the Income-tax Act in the year of maturity.