The finance ministry is expected to announce the abolition of tax deducted at source (TDS) on corporate bonds in Budget 2008-09, official sources told Business Standard.

The move is expected to stoke the near-dormant secondary market in corporate bonds by bringing them on a par with government securities (G-Secs). TDS on G-Secs was abolished in 2000, a move that had a positive impact on secondary trading in these bonds.

The proposal was discussed at a recent meeting at North Block, which was attended by representatives of regulators such as the Securities and Exchange Board of India, the Reserve Bank of India [Get Quote] and the Insurance Regulatory and Development Authority.

The finance ministry's revenue department had initially not been keen to extend the TDS break to corporate bonds on grounds that it would raise the risk of tax evasion since a large number of unorganised retail investors invest in corporate bonds.

"This is a step in the right direction and does not have a significant revenue implication for the government. However, bond-holders should also be allowed the repo [repurchase] option with the Reserve Bank of India, as is the case with government securities," said Abheek Barua, chief economist, HDFC Bank [Get Quote].

TDS has been a major irritant in the corporate bond market because it is not uniformly applicable to all investors, making it difficult to trade bonds between the two classes of bond-holders. For instance, insurance companies and mutual funds are exempt from TDS whereas others are not.

The proposal to scrap TDS on corporate bonds is in line with the growing demands from policy planners in the interest of creating a liquid bond market.

It was a key recommendation of the 2005 RH Patil committee on corporate bonds and securitisation and was seconded by the Deepak Parekh committee on infrastructure financing in its May 2007 report.

In May 2007, the Securities Contracts (Regulation) Amendment Bill, 2007, was passed to provide a legal framework for securitised debt trading. The trading platform for corporate bonds at major exchanges started from July 1.

Market estimates peg investments in corporate bonds through private placements in India at Rs 1,48,000 crore in 2006-07, accounting for around 5 per cent of GDP in that year.

This is in marked contrast with economies like Korea, Japan, Malaysia, Hong Kong, Australia and China, where the size of the corporate bond market exceeds 25 per cent of GDP.