TDS on Interest Income from Bonds - a Pro or a Con?

The new amendment of Finance Bill has created an unavoidable buzz in the Fixed Income Securities Ecosystem. The move to apply TDS on interest of securities by companies has not received a very warm welcome. While a few are questioning the practicality of decision to tab more tax evaders, the others are wary about the plight of senior citizens or investors with income below the taxable limits. Let’s decode this new change and analyse its impact.?

What is Section 193?

As per provisions of Section 193, any person who is paying interest on securities to a resident is required to deduct TDS. The Deductor is liable to deduct TDS @ 10%. However, if the payee fails to furnish his Permanent Account Number (PAN), then, in that case, the Deductor would be liable to deduct TDS at the maximum marginal rate.

As per the Budget announcement from 1st April 2023, all companies paying interest on securities are liable to deduct tax at source of 10%. Unlisted Companies were already covered in Section 193, now as per the latest amendment, listed companies have come under the umbrella of TDS liability on interest payments.

What is the Purpose of Amending Section 193?

This move is expected to plug the under-reporting of interest income by taxpayers. Perhaps, by deducting tax at source, the officials are wishful for more transparency in the system of tax collection and tax-filling.

How have the investors perceived this change?

Investors are certainly not happy about the TDS on their interest incomes. For investors in the lower tax bracket, there is an added hassle to file for Form 15G/H like in case of Bank FDs to avoid Tax being deducted. Many investors depend on this security interest for their livelihood expenses, the cut definitely impacts their cashflows. This move to trace tax evaders has ended up leaving an unpleasant taste to the humbler investors.

Is there still a loophole for the tax evader?

A tax evader can “sell” his way out as he can transfer the security to another investor. We are not trying to highlight the “bond washing transaction” here, but simply a transaction where the investor sells the security very close to the Interest payment date.

(Bond washing transaction means where an investor sells his bond close to the interest date and re-buys it after the interest is paid. Since the bond is ex-interest when repurchased, he stands to make a capital gain and also avoid tax. If the Assessing Officer is satisfied that the transaction has been made with the intention of avoiding tax, such interest shall be deemed as income of the transferor and not transferee. [Section 94(1)])

Bonds and Debentures keep changing hands in the secondary market. The issuer company pays interest only to the registered security holder as on the record date. Securities are not transferred in the books of the Issuer between the Record Date and the Coupon or Interest Payment Date. This is termed the Shut Period. This was implemented to avoid the confusion of coupon payment on a bond in the exact account holder. It is a period of no purchase or sale of securities in order to utilize the time to settle the accounts. As liquidity of the security was getting affected due to long shut period durations, the Reserve Bank of India modified it, to allow dealers to trade bonds during the shut period to improve market liquidity during the period.

Hence, an investor who wishes to evade tax deducted at source may sell his security before the shut period commences. He will be able to sell his security at a higher price since it will be cum-interest. This is a big red flag since

1. The investor escapes TDS as he is not the final recipient of the interest payment.
2. The repurchaser of the debenture will be subjected to 10% interest on the income received whereas his liability would be only for the proportionate period of holding. His only choice to avoid extra taxation is to make adjustments in his return filing for the same. (Refer example below)
3. The income tax authorities would find irregularities in the repurchaser’s tax return, leading to further questioning and assessment. Time and efforts will be wasted till they can track the original investor.

Example: Mr. E purchases 10 years, 12% debenture for Rs. 100,000 on1/4/2023 with annual pay-outs. The interest will be paid on 31st March, every year and the record date is 15th March. Thus making 15-31st March, the shut period.

Mr. E sells the debenture to Mr. R on 1st March,2024 for Rs.1,11,000 (including the accrued interest)

Mr. R will receive Rs. 10,800 after TDS of Rs.1,200. His interest income for AY-2023 will be only Rs.1000. Even assuming the highest tax slab of 30%, his tax liability wouldn’t be more than Rs.300. Mr. R will have to adjust his tax returns accordingly and claim/adjust this excessive TDS. It may lead to an inquiry and assessment procedure.

This is unfair to investors like Mr. R, who would have bought the debentures in good faith. Also, it defeats the purpose of charging TDS on interest payments, since investors like Mr. E, would easily be able to evade the tax by transferring the debenture to another party and extra hassle for the transferee party. The cashflows of organisations around the interest payment dates can get disrupted with this TDS discrepancy. Not to mention, increase in the workload on the income tax office to trace the original buyer and make claims. This can easily happen even in monthly, quarterly and semi-annual pay-outs.

Thus this “con” stunt by the tax evaders can really defy the “pro” of this new tax amendment, not to mention the plight of the submissive category of investors. Surely, a food for thought for the rule makers.

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