Avoidance of Tax by Certain Transactions in Securities- Section 94 of Income Tax Act,1961

A bond washing transaction is a transaction where some securities are sold some time before the due date of Interest and reacquired after the due date is over.

This practice is generally adopted by persons in the higher income group to avoid tax by transferring the securities to their relatives/friends in the lower income group just before the due date of payment of interest. In such a case, interest would be taxable in the hands of the transferee, who is the legal owner of the securities.

In order to discourage such transactions: –

Sec. 94(1) provides that Where the owner of any securities sells or transfers those securities, and buys back or reacquires the securities, then, if the result of the transaction is that any interest becoming payable in respect of the securities is receivable otherwise than by the owner, the interest payable as aforesaid shall, whether it would or would not have been chargeable to income-tax apart from the provisions of this sub-section, be deemed, for all the purposes of this Act, to be the income of the owner and not to be the income of any other person.

[In simple words, where the owner of the securities transfers the security just before the due date of interest and buys back the same immediately after the due date and interest is received by the transferee, such interest income is deemed to the income of the transferor and would be taxable in his hands only.]

94(2) provides that if an Assesse who has beneficial interest in securities sells such securities in such a manner that either no income is received or income received is less than the sum he would have received if such interest had accrued from day to day, then income from such securities for the whole year would be deemed to be the income of the Assesse (i.e. Transferor).

94(7) provides that where:-

a. Any person buys or acquires any securities or unit within a period of three months prior to the record date.

b. such person sells or transfers-

  • such securities within a period of three months after such date; or
  • such unit within a period of nine months after such date;

c. The dividend or income on such securities or unit received or receivable by such person is exempt,

Then, the loss if any, arising therefrom shall be ignored for the purpose of computing his income Chargeable to Tax. Such loss should not exceed the amount of dividend or income received or receivable on such securities or units.

Exception {94(3)}: – provides that the provisions of 94(1) & 94(2) shall not apply if the owner, or the person who has had a beneficial interest in the securities, as the case may be, proves to the satisfaction of the Assessing officer: –

  • That there has been no avoidance of income-tax, or
  • That the avoidance of income-tax was exceptional and not systematic and that there was not in his case in any of the three preceding years any avoidance of income-tax by a transaction of the nature referred to in subsection (1) or sub-section (2)

Example:

Mr. A transfers 10 shares to Mr. B having a face value of Rs.1000/- each for Rs.1025/- each (Cum Dividend) on 15-03-2020, record date being 31-03-2020 and Mr. B sold those shares on 20-05-2020 at Rs.900/- each. Dividend received by Mr. B Rs.300/-(30/- per share*10 no’s). Determine the profit/loss on those transactions?

Profit/Loss accrued to Mr. B on the transaction:-

Particulars Amount
Sale price (10 No’s*900) 9,000.00
Cost Of Acquistion (1025810No,s) 10,250.00
Short Term Capital Gain (1,250.00)
Dividend Received (10 No’s*30) 300.00
Net Allowed STCL (950.00)

Note: – If Mr. A/Mr. B can prove to the satisfaction of the Assessing Officer, that there is no avoidance of tax or the avoidance of income-tax was exceptional and not systematic and that there was not in his case in any of the three preceding years then the net capital loss allowed will be Rs.1250/- instead of Rs.950/-

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