Ex-Interest Securities, Cum-Interest Securities, Bond Washing Transactions

When the seller retains the right to receive the interest or dividend; the transaction is called “Ex-Interest” or “Ex-Dividend” purchase or sale. In other words, when the price quoted is exclusive of accrued interest/dividend, the price so quoted is treated as the capital cost of investment, that is, the buyer has to pay accrued interest due from the last interest date to the date of transaction to the seller along with the cost price of investment.

Interest on debentures is generally paid half-yearly to the holders on certain specified dates, e.g., 30th September and 31st Mach every year. If debentures are purchased exactly on these specified dates, it involves no problem. In such a case, interest is payable to the holders of debentures. But, where debentures are purchased at a date before the specified date of payment of interest the question which naturally arises is whether the price paid for such debentures includes the interest for the expired period (i.e. from the previous date of payment of interest up to the date of purchase) or not.

For this purpose it is important to note whether the price paid for the debentures is quoted as “Cum-interest” or “Ex-interest”. If the purchase price for the debentures includes interest for the expired period, the quotation is said to be “Cum-interest”. If, on the other hand, the purchase price for the debentures excludes the interest for the expired period, the quotation is said to be “Ex-interest”. In case of Ex-interest quotation, interest has to be paid to the holders for the expired period in addition to the price paid for the debentures. In any case, the company must pay interest for the expired period and while making entry in its books at the time of purchase of the debentures, the amount paid by way of interest should be treated separately from the price actually paid for the debentures. For example, if a company purchases 10 of its 9% Debentures of 100 each at 95 each on 1st August, 2014 the dates of payment of Interest being 30th September and 31st March, the treatment of the same for “Cum-interest” and “Ex-interest” quotations will be as follows:

N.B. If nothing is stated, purchase and sale of debentures and government securities should be taken to be on ex-interest basis. That of shares should be presumed to be on cum-dividend basis.

(1) In case of cum-interest quotation: If the purchase price of 95 is taken to be the cum-interest price, it implies that this includes the interest for the expired period of 4 months (i.e. from 1st April, 2014 to 31st July, 2014 which amounts

Bond Washing Transactions

Bond washing transactions are the transactions in Securities which leads to shift in income. Now one may think that the provision of shifting may lead to the provision of clubbing. But, what about transfer in case transfer is made to friend? The Clubbing provisions do not apply. For such cases Section 94 of Income Tax Act 1961, comes into picture.

Section 94 aims at preventing avoidance of tax by an assessee where there is a transfer of securities before the due date of payment of interest and re-acquisition thereof after due date. Such transfer avoids tax or shifts the burden of tax to some other person. As per Section 94, the income of the securities transferred shall be deemed to be that of the transferor and shall be assessable in his hands accordingly and therefore bond washing transactions shall have null effect.

For example, Mr. Ram holds 12% debentures of Rs. 1 crore of Company “A”. Company “A” provides interest half-yearly say on 30^th June and 31st December.

On 28th June 2018, Mr. Ram sells the said debentures of Rupees 1 crore to his friend Mr. Shyam and re-acquires those debentures on 1^st July 2018. Now interest of rupees 6 lakhs received by Mr. Shyam shall not be taxable in hands of Mr. Shyam but shall be taxable in the hands of Mr. Ram by virtue of Section 94 of the Act.

However, Section 94 shall not apply and the said interest shall not be taxable in hands of Mr. Ram:

• If Mr. Ram proves that the interest is taxable in hands of Mr. Shyam at the same rate as it would have been taxable in his hands i.e. proves that there is no avoidance of income tax or
• Mr. Ram proves that he sold debentures on 28th June 2018 as he was in urgent need of money and there has been no such Bond washing transaction in any of the three previous year ending 31st March 2018.

Explanation to Section 94(1) provides that if transferor re-acquires similar type of securities, then his tax burden shall not be greater than or less than what would have been if he had sold original securities.

Accordingly if Mr. Ram buy backs on 1^st July 2018 shares of Company “B” with interest of 11%, then still the amount that will be added to Mr. Ram’s income would be Rs. 6 lakhs (1cr * 12% * 6 / 12) and not Rs.5.5 lakhs ( 1cr * 11% * 6 / 12).

So, Bond Washing Transactions can be done, provided the person produces the evidence showing urgency of money or that there is no tax avoidance.