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Suresh KrishnamurthyS. K.

THE Central Board of Direct Taxes has issued a circular dated February 15, 2002 that changes the way the income from Deep Discount Bonds are taxed.

For investors who hold Deep Discount Bonds with an aggregate face value of more than Rs 1 lakh, tax will be payable on the income accrued on an annual basis.

For investors holding Deep Discount Bonds with an aggregate face value of less than Rs 1 lakh, they can continue to offer tax at the year of maturity.

However, it is important to note that the eligibility for tax-deferral is with reference to the face value — that is the amount receivable on redemption and not the issue price, which is the amount invested.

Due to the change, Deep Discount Bonds whose attractiveness stemmed from tax-deferral to the year of maturity may now offer lower after-tax returns compared to plain vanilla bonds.

As such, investors who hold more than Rs 1akh of Deep Discount Bonds may be better off avoiding them.

Others, however, can continue to invest in them if it makes sense, that is, if the limit under Section 80L has been exhausted and investors are unlikely to reinvest interest receipts.

Both ICICI and IDBI offer Deep Discount Bonds. The Tax Saving Bonds offered by ICICI and IDBI have options that are in the nature of deep discount bonds.

Ideally, these may be considered for investment since the term-to-maturity is usually short. Investors, because of the longer term to maturity, need not consider the Money Multiplier Bonds offered by ICICI and IDBI.

The credit risk associated with the investments of both ICICI and IDBI are perceived to be high. As such, investing in long-term bonds offered by these two institutions can be avoided for now.

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