What Is Bond Washing?

Malcolm Tatum

Bond washing is a practice that involves choosing to sell a bond at a point just before some sort of benefits or coupons are received from the issue, then arranging for the repurchase of that bond within a certain period of time. This approach is sometimes used as a means of minimizing taxes that are due on investments, since the two-pronged strategy involves a couple of transactions designed to essentially offset or wash the other out. Considered a type of tax evasion, many nations now have regulations against the use of this type of strategy, and may impose fines and other punitive measures up to and including imprisonment if an investor is found using this approach.

Man climbing a rope
Man climbing a rope

The process of bond washing usually requires careful timing, in that the sale of the bond must take place just before an interest or coupon payment is due to occur. A willing buyer is found and a deal is struck for the buyer to purchase the bond issue and to receive the coupon payment in the capacity of being the new bond holder. As part of the arrangement, the buyer agrees to sell the bond back to the original owner at a date after the tax period closes, usually at the same amount as the original purchase price arranged between the buyer and the seller. For his or her cooperation, the buyer retains the coupon payment. The original investor is able to regain control of the bond for later use, but manages to avoid receiving the coupon payment and paying any taxes that may have resulted from that income.

Bond washing can be used with just about any type of bond issue that is configured to provide periodic coupon payments. The process is less likely to produce any benefits when the bond only pays off at maturity. In any event, the benefit received from utilizing what is considered at best to be an unethical strategy is often minimal and not worth the risk associated with being discovered and receiving some sort of punishment for engaging in the process.

Since the benefits of bond washing are somewhat questionable, anyone tempted to try this process in order to avoid paying a portion of taxes should look closely at the benefits versus the risks. This includes determining how much of a tax break the strategy would provide, and comparing that figure to the amount of the lost coupon payment and the type of fines or other punitive measures that may come about if the activity is discovered due to an audit or some other series of events. Given that revenue agencies around the world are imposing increasingly harsh fines for engaging in any type of tax avoidance, the benefit of bond washing is highly unlikely to be worth the risk.

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