Clarifications regarding tax treatment of deep discount bonds and STRIPS (Separate Trading of Registered Interest and Principal of Securities)

Accrual taxation of deep discount bonds: annual mark-to-market accrual taxed as interest or business income.

Income from deep discount bonds is to be taxed annually by marking each bond to market on the financial year valuation date under RBI valuation guidelines; the increase between successive valuation dates is taxable as interest income for investors or business income for traders. On transfer before maturity, sale proceeds over adjusted cost (acquisition cost plus income already taxed under annual valuation) are taxable as capital gains for investors or business income for traders. On redemption, taxable income equals redemption price less last valuation date value (or adjusted cost for intermediate purchasers). STRIPS follow the same treatment and stripping/reconstitution is not a transfer.