Bond Washing Transaction

Example

Suppose there are 2 persons A and B

A had business income of Rs 3 lakh 

Mr A also had Interest Income on bonds of Rs 10000

(Bonds of Rs 1 lakh having interest rate 10% per annum

His friend B had no other income

Tax Payable on both Income was

Mr A dones some Tax Planning to save his tax

Mr A sold these bonds to his friend B for 100000 before Interest was due and repurchased it for 90000 after interest was received by B

After interest was earned,Mr A repurchased bonds from B 

Tax Saved by A=410-3090=1030

Extra Tax paid by B=0-0=0

A also was able to save tax on such interest income as he did not earn interest income

B received the interest since he had no other income, his income became tax free.

This kind of tax planning to avoid tax is called Bond Washing transaction

A bond-washing transaction is a transaction where securities are sold sometime before the due date of interest

and

reacquired after the due date is over.

This is done 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 to avoid paying the tax

  In order to avoid such tax planning section 94 was introduced 

Section 94(1)

As per this section if any person sell any securities and buy back the same in order to save interest such interest shall be deemed to be the interest income of transferor and not transferee

Hence because of this section, it is the income of A and not B.

Exception

However in this case transferor (A) can avoid paying tax if he can prove to the satisfaction of AO that

That there was no avoidance of Income tax   [B also paid tax on it]

Or

Tax avoided was exceptional and not systematic   [i.e.,transaction was not deliberately done to save tax]