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Postby chandniwadhwani92 » Mon Jan 12, 2015 10:34 am

Taxation of bond income
Some tax jurisdiction issue bonds at a premium to par provides a symmetric treatment ,allowing part of premium to b used to reduce taxable portion of coupon interest payments
MY question
How taxable portion would be reduced by issuing bonds at premium

PURE DISCOUNT AND OTHER BONDS SOLD AT DISCOUNT TO PAR WHEN ISSUED ARE TERMED AS ORIGINAL ISSUE DISCOUNT. The tax basis also allows that the tax basis of OID bonds is increased each year by the amount of interest income recognized , so there is no additional tax liability at maturity

source of questions- SCHWESER

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Postby edupristine » Mon Jan 19, 2015 7:46 am

hi, your answer to both question is that bond moves automatically to par whether issued at discount or premium. this is the concept of constant price trajectory. in some jurisdictions bonds are tax deductible so they use the amount of premium to reduce taxable portion. taxable portion will be reduced constantly according to the coupon payment timings.
Also, as there are no coupon payments in the pure discount bonds and they are paid once at the par. amount received at the par is more than what the investor paid in the beginning so the amount is interest income and the bonds automatically deduct taxes from the interest income and hence there are no capital gains or tax liability at the future when bonds are redeemed.

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