All about Bond Washing & Bond Washing Transaction

what is bond washing transaction

Before getting into the concept of bond washing transactions, it would be helpful for you to know, what bond washing is as both the terms are interconnected.

Bond Washing is the practice of selling bond units just before the interest payment by the bond issuer and buying the units back once the interest payment date is over.

You may be thinking that we buy bonds to get the interest rates, then why would someone want to skip the interest payment by the bond issuer?

There’s a catch here, and we have broken down this concept in this article. We have answered, ‘what is bond washing transaction?’ and other related terms in the further article.

Keep reading!

What is Bond Washing Transaction?

Bond washing transaction is the transaction of bond units between investors of a high-income group (seller) and their friends or relatives (buyer), who fall under the low-income tax bracket.

So, bond washing transaction is done by a high-income bondholder and their friend/relative.

Seller’s benefit in bond washing transaction:

High-income-tax-bracket bond investors need to pay taxes to the government whenever they receive interest/coupon payments from the bond issuer.

And to save the tax, they sell their bonds to their friends just before the interest payment date, and after the interest due date bought them back. In this way, the seller on the interest payment date does not own bond units and hence does not get the coupon and gets taxed.

You can ask, what’s the meaning of selling and buying the same bond units? The investor of the high-income group can pay their taxes from the interest payment.

But, the problem is that the levied tax by govt. is generally higher than the paid interest by the bond issuer.

Let’s know, how the seller benefits from the transaction.

If you didn’t know, let us tell you that after the bond interest payment date, the bond price reduces by the amount of paid interest/coupon.

The seller sold the bond at a higher price (before the interest payment date) and bought it back at a lower price (after the interest due date) and didn’t even pay the taxes; this is how sellers take advantage of bond washing.

Buyer’s benefit in bond washing transaction:

The buyer is not any random person, he/she is a friend or relative of the seller. Buyers just help the seller to save their taxes.

Buyers buy bonds at a high price (before the interest due date) and sell at a low price (after the interest due date).

But, they recover the loss by the interest payment they get on bought units of bond, and they also do not pay taxes as they fall into the lower income group.

Bond Washing Transaction in Income Tax

It would appear to you that it is a win-win situation for both buyer and seller to perform bond washing. But think for a moment, from whom the seller wanted to save tax?

It’s the government that is asking for tax and the government in turn uses this tax money in the nation’s growth.

So, it should be clear to you that whoever is involved in bond washing transactions are tax evader and the income tax department punishes them when it captures such people.

If the bond seller fails to convince the tax department that he sold bonds in need of money and bought them back when he had enough, then the department levies a penalty on them.

Conclusion

Bond washing is the practice of selling a bond before the coupon payment due date and buying it after the interest is paid.

The bond washing transaction is done by investors of the high-income class and their friends or relative. Bond washing is an illegal way to evade taxes.

When found, the people involved in this practice are penalized by the tax department as bond washing transaction in income tax is considered illegitimate.

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