Tax Free Bonds have emerged as one of the most popular investment options for moderate risk appetite investor as well as HNIs (High Networth Individuals). In 2013, Tax Free Bonds were offered and had been massive hit, gained lots of attention due to the taxation benefits they offer.
This year also Government has given permission to seven entities to raise funds through the route of Tax Free Bonds worth Rs.40,000/- crore.
Tax Free bonds will provide an opportunity to the investors to fetch returns at higher interest rate in this declining rate scenario. Let’s dive into the details of the tax free bonds together with the upcoming issues.
List of tax free bonds in India 2015
Government has permitted top seven state owned entities to sell tax free bonds in the current financial year to raise corpus of Rs.40,000/- crore as below:
What are the Tax Free Bonds?
Tax Free Bonds is a document containing the details of transaction of lending of money by bond holder to an entity (usually Government entities or PSUs) at a prefixed interest rate (coupon rate) for a predetermined time period.
Tax Free Bond are similar to any other coupon bearing bonds which provides a fixed income but unlike other bonds, the interest income from tax free bonds is exempt from taxation u/s 10 of the Income Tax Act, 1961.
History of the Tax Free Bonds
Tax Free Bonds were first issued in the financial year 2011-12 to raise funds of Rs.30,000/- crore and subsequently in each following year but were absent in the last financial year i.e. 2014-15.
The funds raised through these bonds are usually placed in the infrastructure sectors which require funds for longer term as in comparison to any other sector.
The two of the issuer has proposed to use the proceeds to part-finance their capital expenditure and also to utilize the issue to finance the ongoing new or upcoming projects.
Conditions regarding the issue of Tax Free Bonds 2015
1. Eligibility of Buying Tax Free Bonds
The following investors are eligible to park their money in Tax Free Bonds:
- Retail Individuals Investors (RII) including HUF (Hindu Undivided Family) and Non-Resident Indians (NRIs).
- Qualified Institutional Buyers (QIBs) as defined in the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000.
- Corporates (including statutory corporations), Limited Liability Partnerships (LLPs), partnership firms, trusts, co-operative banks, regional rural banks and other legal entities; and
- High Networth Individuals (HNIs) i.e. investors whose total investment in each issue exceeds Rs.10 lakhs.
2. Interest Rate of Tax Free Bonds
An investor can earn interest rate ranging from 7.3% p.a. to 7.5% p.a. depending on the ratings of the entities assigned by a credit rating agency which are as follows [A basis point (bps) is 0.01 per cent]:
- AAA Rated Issuer will provide interest rate which is 55 basis points lower than similar maturity G-Sec yields. National Highways Authority of India (NHAI) and Indian Railways Finance Corporation are AAA rated entities.
- AA+ Rated Issuer will provide interest rate which is 10 basis points above the interest rate offered by AAA rated issuer or 45 basis points lower than G-Sec yield. HUDCO is AA+ rated entity.
- AA or AA(negative) Rated Issuer will provide interest rate which is 20 basis points above the interest rate offered by AAA rated issuer or 35 basis points lower than G-Sec yield. Currently none of the above permitted seven entities hold AA or AA- ratings.
3. Tenure of Tax Free Bonds
Tenure of the Tax Free Bonds shall be 10-15-20 years. It is not necessary that each of the issuer offers all three tenures. There may be one or two offerings by each issuer.
4. Interest Payment
The interest on tax free bonds is paid out annually and credited directly in the bank account of the investor.
5. Proportion of Offering
The notification issued by CBDT has mandated the companies to raise not less than 70 percent of the funds through public issue (remaining 30 percent shall be raised through Private Placement). Further, 40 percent of the issue shall be earmarked for Retail Individual Investors (RIIs).
Tax Implication on Tax Free Bonds
Having Tax Free as prefix does note made tax free bonds completely out of the purview of income tax. Let’s understand the taxation implications on tax free bonds:
1. Deduction of Invested amount u/s 80C
Tax Free Bonds is not an eligible investment u/s 80C and thus does not offer any deduction of the invested amount under section 80C.
2. Applicability of TDS on Interest Income
Interest Income from Tax Free Bonds is an exempt income u/s 10 of the Income Tax Act, 1961, thus no TDS is applicable on the yearly interest income.
3. Capital Gain Taxes
Buying and Selling Tax Free Bonds in the secondary market attracts capital gain tax. If you sell TFBs within 12 months of buying than you will have to pay tax on the gains made as per your tax slab and if your holding period exceeds 12 months than tax has to be paid at flat rate of 10% and the benefit of indexation is not available.
How to Invest in Tax Free Bonds in India?
The simplest way to subscribe or buy Tax Free Bonds is at the time of opening of bonds for subscription by the issuer. The subscription window is open for few days in which you can buy bonds either in physical form or demat form. Investor is required to furnish Permanent Account Number (PAN) to the issuer of the bonds if opting for physical form.
Another way to buying Tax Free Bonds is thorough secondary market. But TFBs are less liquid and chances of buying them through stock market are very thin.
How to Redeem Tax Free Bonds?
Tax Free Bonds are backed by the Government which reduces the risk of non-repayment or credit risk of getting your capital back on the maturity. But you must remember that these bonds come with a lock-in-period of 10 to 15 years which means you cannot withdraw money before the lock-in-period gets over.
Though Tax Free Bonds are free traded in the stock market and can be easily bought and sold through the secondary market. But what makes it not so easy is they are not traded frequently and chances of redeeming it before maturity is really very narrow.
Tax Free Bonds Vs. PPF Vs. Tax Savings Bank FDs
Should You Invest in Tax Free Bonds?
Though Tax Free Bonds gives consistent returns for a long term i.e. over 10 to 20 years but putting money for such a long term is only advisable if you have enough surplus money because tax free bonds are less liquid as they are seldom traded in secondary market.
But if you fall in the highest tax bracket of 30% than you can consider including tax free bonds into your portfolio as the post-tax returns from Tax Free Bonds would be better than investing in any other similar debt oriented investment option.