An Attractive Investment Option-Tax Free Bonds

The beginning of 2014 will usher with the offers of Tax Free Bonds from PSU’s. Tax free bonds have emerged as a popular investment option due to the lucrative taxation benefits they offer. The interest income on these bonds, generally issued by government enterprises, is exempted from taxation. For a better understanding lets probe it:

What are Tax Free Bonds?

When you purchase a bond, it implies that you are lending money to an organization for which you will be paid a Fixed Rate of interest during its tenure. And when the government notifies that interest earned on it will not be taxed then it is called Tax Free Bond. In India the Tax free Bonds are issued by government or PSU’s for a fix term say 10 years, 15 years, 20 years e.t.c. Further these bonds shall be rated by agencies like CARE, FITCH, CRISIL, ICRA enables you to assess the quality of instruments. Since interest received is tax free so after tax returns works out to be higher. Some of the public undertakings that will be raising funds are IIFC, IRFC, PFC, NHAI, HUDCO, REC, NTPC, NHPC, Indian Renewable Energy Development Agency, Airports Authority of India and Cochin Shipyard.

Return on Bonds.

The general prevailing rates of interest on these bonds are from 8% to 9% depending upon the type and tenure of Bonds. It is pertinent to note that since these are tax free so effective Tax equivalent yield on a 8% investment comes out to be 12.14%, 10.63%, 9.44% for 30%, 20% and 10% Tax bracket respectively.

How to Invest?

Investor may apply in Demat as well as Physical Mode with required documents as mentioned in the respective prospectus

Advantages of Tax free Bonds

  1. Free Income: The interest earned from such bonds is not subjected to any taxation and hence they are known as tax-free bonds.
  2. Tax Free Bonds can be traded: Tax-free bonds are listed on National Stock Exchange and Bombay Stock Exchange for trading and one can easily sell them off in secondary market before the end of the tenure without suffering any penalty.
  3. Price of Bonds may increase: Prices of bonds may fluctuate with interest rates. If interest rates goes up then the Price of Bond may come down and vice versa. So, if one invests in tax-free bonds and interest rate goes down, one can then easily sell the bonds at a higher price. This surplus amount earned is known as capital gain.

Taxation Aspect

  1. Interest Income: Interest income earned on these bonds is not subjected to any tax.
  2. Maturity Amount: The amount received at the expiry of its tenure will not be subject to any tax.
  3. Capital Gain: These bonds can be sold in NSE or BSE. If it is sold at higher rates then the profit accruing to it will be termed as Capital Gain. While short term capital gains from such a sale will be taxed as normal income, long-term capital gains will be taxed at 10%. The bonds must be held for at least 12 months for the profits to be treated as long-term gains. Unfortunately for investors, the long-term capital gains from these bonds are not eligible for indexation benefit which could have reduced tax.

Thus here we find a good number of reasons for all not to miss current issues of Tax free bonds for their higher post tax returns and that too especially for the group falling in higher tax brackets. Say the post tax return for a 30% tax bracket will settle for around 12.14% which is only 8-9% in case of FDRs. The only flipside for some investors is that since the payout of the interest is yearly so the interest does not get reinvested as compared to FDR. Hence, a fine tune balance can help you gain maximum out of this attractive investment option.

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