What is Bond-washing Transactions?
Bond-washing Transactions is a practice of selling a bond just before it pays a coupon payment and then buying it back once the coupon has been paid. Bond-washing results in a tax-free capital gains because after the coupon has been paid the bond will sell for less. We may say bond-washing is a form of tax evasion, whereby buyers and sellers may collude to benefit from tax avoidance, it has been banned though the practice still exists.
Generally, it happens that securities earn interest on a half-yearly or an yearly basis on a specific date the interest on securities is payable to the person who holds the security on the date of accrual of the interest. Taking advantage of this, some people sell their securities a few days before the due date of interest payment.
On that day, they do not remain the owner of the securities and thus, do not have to pay tax. What they do is they sell their securities to persons who fall in the no-tax bracket or they fall in a lesser income bracket, so that either less tax or no tax is paid. Thus, very cleverly tax has been evaded or lesser tax has been paid. If tax is paid on a lower rate, it is secretly paid by the actual owner of the security to the owner for the time being.
Such transactions are labelled as bond-washing transactions. The general rule that tax is payable by the person who is the owner of the securities on the due date of interest does not apply to bond-washing transactions. In order to prevent such transactions, Income-tax Act has a specific provision to this regard [Section 94(1)] which sees to the fact that in case of Bond Washing Transactions the person transferring such security is taxed instead of the one who is shown as the purchaser of the security.