10 things you need to know about tax-free bonds

Finance Minister P Chidambaram in his Union Budget proposed that certain companies were permitted to issue tax free bonds (TFBs) in 2013-14. In fact, in 2011-12 such bonds worth Rs 30,000 crore were issued. In 2012-13, Rs 25,000 crore worth of bonds were to be issued. This clearly means there are a lot people who are investing in these bonds. If you think you have missed the bus, and want to know about these bonds, read on.

[caption id=“attachment_648971” align=“alignleft” width=“380”] Before investing in these bonds, it’s always good to check the credit rating. Moneycontrol.com[/caption]

What: These bonds are offered by government-backed entities and as the name suggests these are tax-free instruments. This means that the interest which you earn from investing in these bonds gets a tax exemption as per the income tax laws. Usually, these bonds are secured non-convertible bonds and come with a face value of Rs 1000.

More from Investing

MSMEs are breaking the traditional convention. Look who’s funding them Scale-up your startup without an investor! Here’s how

Who: There are four types of investors which these bonds seek - qualified institutional buyers, domestic corporates, high net-worth investors and retail individual investors.

Where: Many government entities have come up with their public issue of TFBs in the recent past, for instance IIFCL, HUDCO and IRFC to name a few.

Features:

Minimum Application: Five Bonds (Rs 5,000) individually.

Tenure: These bonds usually come in the tenor of 10 and 15 year. A few entities also offer a 20-year tenor bonds. But keep in mind that these bonds do not come with a lock in period and you can trade theses bonds on the stock exchange, at times even at a premium. The bonds are listed on the BSE and / or the NSE.

Rating: Before investing in these bonds, it’s always good to check the credit rating given by various credit rating agencies such as CARE, ICRA and Brickwork Rating India Private Limited. The rating of AAA is considered stable. Keep in mind that the higher the rating the lower the risk and vice-versa. But since TFBs are issued by government-backed entities, they are considered relatively safe.

Finer details: Usually these bonds do not come with an upper investment limit. They don’t have call and put options. Currently, the coupon rate is in the 7.36-8.00 percent range. The market lot/ trading lot is one bond.

Things to keep in mind: You need to have a PAN to buy these bonds, but demat account is not compulsory, since these bonds can be held in physical form as well.

Keep in mind that these are tax-free and no tax savings in nature. This means that though the interest you earn is exempted from tax, you do not get a deduction under any sections of the IT laws when you invest in these bonds.

Tax: As mentioned earlier, interest from these bonds do not form part of total income, and hence it’s a tax-free bond. But when you sell the bond on the exchange, you will have to pay a capital gains tax. As per the income tax law, if you sell the bond after 12 months, the capital gains will be calculated as per 10 percent without indexation. If you are not the original allottees of the bond and bought it from the secondary market, the coupon rate will be lower by 50 bps then the applicable coupon rate for the retail investor.

Should you invest? On maturity, the principal amount is returned to the investor, along with the interest amount. One important thing to remember is that interest rate is inversely proportional to the price of any bond. In other words, the higher the interest rate, the lower the price and vice-versa. As of now, these bonds are offering fairly good amount of returns that too tax-free. So, in the current economic scenario, returns you earn on these bonds are higher than FD. But in the future when the macro economic scene changes, you will have to compare interest rates of these bonds with FDs. But, generally, these bonds work well especially for those in the highest tax bracket. You should first look at investing in PPF, if it offers a higher rate than these bonds. And, once you’ve exhausted the PPF limit, you may consider investing in these bonds.