What are Bond Washing Transactions with Example

Bond Washing Transactions are dealt with in section 94 of the Income Tax Act. Section 94 has been introduced to capture the tax evaders who just do a single transaction at the end of the year to avoid payment of tax on a particular transaction.

To Understand Bond Washing Transaction Law

First, we have to get an understanding of what people used to do earlier before the law was introduced.

Let's say there is a person Named "X" who is in the Tax bracket of 30 percent and surcharge bracket is 37 percent and there is a person Named "Y" who is in the Tax bracket of 30 percent but surcharge bracket is "0" percent. Now Mr. X who is holding security which will pay interest income to Mr. X at the end of the year, so to avoid the burden of Security's interest, what Mr. X will do is that He will transfer the security to His Friend Mr. "Y" on 28th of March which is the year-end. Now the interest receivable on Security is due to Mr. Y and taxable in the hands of Mr. Y. After the Interest is received on the due date, Mr. Y transfer the security back to Mr. X. So in this way Mr. X has avoided the tax on interest income by transferring the security temporarily to Mr. Y.

Section 94 - Bond Washing Transaction

Section 94 of the Income Tax Act has been introduced to prevent such transactions. This section states that if any person transfers any security to another person and the main purpose of such transfer is to avoid or reduce the tax liability on the interest income, then the interest income will be deemed to be the income of the transferor and not the transferee.

Provisions of Section 94

Section 94(1): If any person transfers any security to another person and the main purpose of such transfer is to avoid or reduce the tax liability on the interest income, then the interest income will be deemed to be the income of the transferor and not the transferee.

Section 94(2): If any person transfers any security to another person and the main purpose of such transfer is to avoid or reduce the tax liability on the dividend income, then the dividend income will be deemed to be the income of the transferor and not the transferee.

Section 94(3): If any person transfers any security to another person and the main purpose of such transfer is to avoid or reduce the tax liability on the capital gains, then the capital gains will be deemed to be the income of the transferor and not the transferee.

Section 94(4): If any person transfers any security to another person and the main purpose of such transfer is to avoid or reduce the tax liability on the interest income, then the Assessing Officer may, if he is satisfied that the transfer was made with the main purpose of avoiding or reducing the tax liability, treat the interest income as the income of the transferor.

Section 94(5): The Assessing Officer may ask the Securities dealer to furnish the details of the securities held by the dealer by serving a notice upon the dealer for not less than 28 days.

Example of Bond Washing Transaction

Scenario: Mr. X is in the 30% tax bracket with 37% surcharge, and Mr. Y is in the 30% tax bracket with 0% surcharge. Mr. X holds a security that will pay interest at the end of the year.

Transaction: Mr. X transfers the security to Mr. Y on March 28th (year-end). The interest is received by Mr. Y and taxed in his hands. After receiving the interest, Mr. Y transfers the security back to Mr. X.

Impact: Under Section 94, the interest income will be deemed to be the income of Mr. X (the transferor) and not Mr. Y (the transferee), thus preventing the tax avoidance.

Important Points

1. The section applies to transfers made with the main purpose of avoiding or reducing tax liability. 2. The Assessing Officer has the power to treat the income as that of the transferor if satisfied that the transfer was made to avoid tax. 3. Securities dealers may be required to furnish details of securities held by them. 4. The section applies to interest income, dividend income, and capital gains.

Conclusion

Section 94 is an important anti-avoidance provision that prevents taxpayers from avoiding tax by temporarily transferring securities to other persons. It ensures that the tax liability remains with the original owner of the security, maintaining the integrity of the tax system.