I hold ten Deep Discount bonds issued in 1996 by ICICI Bank with face value( redemption value) of Rs. 16000 each.The issue price was Rs. 4000 each. I have not declared interest accrued annually in my tax return. The Bonds shall be due for redemption in October 2008. Please inform the best way to save income tax. Sharad, Delhi

Remember , in case Deep discount bond, two kinds of income may generate in two different conditions;

1. If the bond matures, the redemption price  minus the issue price will be charged as interest income.
2. If you sale before maturity, the difference between Sale price and issue price will be charged to capital gains.No indexation is allowed as section 48 of the I T Act does not permit indexation incase of bonds and debenture.

Since the tax rate in case of long term capital gains is 20 % , selling before maturity is better tax planning if your total income happens to be in 30 % rate bracket .

In your case , the total interest chargeable to tax comes to Rs. 1,20,000 (RS 12000 x 10). I presume, combined with other income, the tax rate applicable in your case must be 30 % .

Therefore, it is certainly beneficial to sale the bond before the maturity, so that difference between the sale price and issue price is charged to capital gains and income from other sources. That way not only tax rate will be 20 % but if you want exemption you can invest insale price in residetaila hoiuse pruchase for sectuon 54 F benefit or can purchase specified bonds as stated u/s 54 E .

Non Declaration of Interest Every Year

Since you had subscribed to the bond in 1996, Circular No 2 of 2002 dated 15.2.2002 is not applicable in your case . This circular made it compulsory for subscriber to Deep Discount Bond , to declare the accrued interest every year. The relevant portion of the circular is given below:

3. The matter has now been examined in consultation with the Reserve Bank of India and the Ministry of Law. The practice followed in several countries outside India has also been examined. With a view to remove the anomalies in the existing system of taxation of income from Deep Discount Bonds, and to formulate a system which is more in line with international practice, the Board have decided that such income may hereafter be treated as follows.

General treatment

4. Every person holding a Deep Discount Bond will make a market valuation of the bond as on the 31st March of each Financial Year (hereafter referred to as the valuation date) and mark such bond to such market value in accordance with the guidelines issued by the Reserve Bank of India for valuation of investments. For this purpose, market values of different instruments declared by the Reserve Bank of India or by the Primary Dealers Association of India jointly with the Fixed Income Money Market and Derivatives Association of India may be referred to.

4.1 The difference between the market valuations as on two successive valuation dates will represent the accretion to the value of the bond during the relevant financial year and will be taxable as interest income (where the bonds are held as investments) or business income (where the bonds are held as trading assets).

4.2 In a case where the bond is acquired during the year by an intermediate purchaser (a person who has acquired the bond by purchase during the term of the bond and not as original subscription) the difference between the market value as on the valuation date and the cost for which he acquired the bond, will be taxed as interest income or business income, as the case may be, and no capital gains will arise as there would be no transfer of the bond on the valuation date.

Transfer before maturity

5. Where the bond is transferred at any time before the maturity date, the difference between the sale price and the cost of the bond will be taxable as capital gains in the hands of an investor or as business income in the hands of a trader. For computing such gains, the cost of the bond will be taken to be the aggregate of the cost for which the bond was acquired by the transferor and the income, if any, already offered to tax by such transferor (in accordance with para 4 above) upto the date of transfer.

5.1 Since the income chargeable in this case is only the accretion to the value of the bond over a specific period, for the purposes of computing capital gains, the period of holding in such cases will be reckoned from the date of purchase/subscription, or the last valuation date in respect of which the transferor has offered income to tax, whichever is later. Since such period would always be less than one year, the capital gains will be chargeable to tax as short-term capital gains.

Redemption

6. Where the bond is redeemed by the original subscriber, the difference between the redemption price and the value as on the last valuation date immediately preceding the maturity date will be taxed as interest income in the case of investors, or business income in the case of traders.

6.1 Where the bond is redeemed by an intermediate purchaser, the difference between the redemption price and the cost of the bond to such purchaser will be taxable as interest or business income, as the case may be. For this purpose, again, the cost of the bond will mean the aggregate of the cost at which the bonds were acquired and the income arising from the bond which has already been offered to tax by the person redeeming the bond.

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Tax deduction at source

8. The difference between the bid price of a deep discount bond and its redemption price, which is actually paid at the time of maturity, will continue to be subject to tax deduction at source under section 193 of the Income-tax Act. Under the existing provisions of that section, no tax is deductible at source on interest payable on Government securities. Further, the Central Government is empowered to specify any such bonds issued by an institution, authority, public sector company or co-operative society by way of notification, exempting them from the requirement of tax deduction at source.

Circular : No. 2/2002, dated 15-2-2002.

However , Clarifications were issued vide press release dated 20/3/2002 that the circular no 2 of 15/2/2002 is not applicable for bonds issued before 15/2/2002.

It is also an established principle that a circular issued by CBDT cannot have a retrospective tax effect. The present circular on deep discount bonds, therefore, specifies the tax treatment in respect of bonds which are issued after the issue of the circular, and does not seek to impose the modified treatment on existing bond-holders. Further, non-corporate persons who invest small amounts in new issues (face value upto Rs.1 lakh) can still opt for the old system.

Therefore, even if you did not declare the interest every year, it is not a problem.