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  • Tax Free Bonds

    Tax free bonds have acquired a lot of popularity these days considering that the interest income earned from these bonds are free from being taxed. These bonds are issued by government enterprises and there is hardly risk of non-payment of interest amount. The tax free bonds provide fixed rates of interest. The profits from these bonds usually get invested in infrastructure projects.

    Tax free bonds come with a long term maturity period of 10, 15, and 20 years. The major issuers of tax free bonds in India are Power Finance Corporation, Indian Railway Finance Corporation and NHAI to name a few.

    Benefits of Investing in Tax Free Bonds

    Tax free bonds come with a lot of attractive benefits. Listed below are the major benefits offered by tax free bonds:

    • Investors can enjoy tax benefits by investing in tax free bonds. These bonds are 100% tax free. The interest income received from these bonds is calculated as a part of your total annual income.
    • You get higher interest rates on your invested amount. Tax free bonds provide good returns on your investments.
    • Interest is paid on these bonds annually. It gets directly credited in the bank account of the investor.
    • Tax free bonds provide steady returns for longer terms such as 10 and 20 years.

    Tax Saving Bonds vs Tax Free Bonds

    There are a few differences between tax free bonds and tax saving bonds. The major differences between tax free bonds and tax savings bonds are:

    • In tax-free bonds, the interest income earned from investing in them are free from taxation as per the Section 10 of the Indian Income Tax Act, 1961. But, the tax saving bonds don't offer this benefit. In a tax saving bond, only the initial investment is free from tax.
    • Compared to tax saving bonds, tax free bonds offer slightly higher rates of interest, and any retail investors can invest in tax free bonds up to Rs.5 lakhs.
    • Tax savings bonds are investment instruments for individual investors who get tax exemption on investing a maximum amount of Rs. 20,000 under Section 80CCF of the Indian Income Tax Act. The same is not applicable for tax free bonds which are absolutely free. Given that you can invest a maximum of Rs. 20,000, tax-saving bonds may not serve you as the investment tool for investment. You would not receive regular cash flows by investing in tax saving bonds.
    • In tax free bonds, you need to invest your money for a particular lock-in period. But, in tax saving bonds, you don’t have to do so. The tax saving bonds offers you a buyback clause at the end of each 5 or 7 years which enables you to withdraw your investments. However, tax saving bonds are ideal for those people who have low risk appetite.

    Things to Remember before Opting for Tax Free Bonds

    Wisely chosen bonds can act as safe haven for your investments. In this case, tax free bonds can serve as an ideal investment tool as they are totally free from tax payment. However, before investing in tax free bonds you need to know the basic facts about tax free bonds and how they function:

    • Tax free bonds come with a lock in-period of 10 to 20 years. The amount invested in a tax free bond cannot be withdrawn before the expiry of applicable lock-in period.
    • The interest income earned from these bonds are completely free from income tax.
    • Tax free bonds can be transacted in stock exchanges. Any investor can buy and sell these tax free bonds on the stock exchanges.
    • Although the interest earned by investing tax free bonds is not taxable, any capital gains received from selling these tax free bonds in the secondary market are taxable.
    • Tax free bonds are issued both in demat format and physical mode.
    • Credit risk or the risk of non-payment is very low in tax free bonds as these bonds are mostly issued by the government enterprises.
    • Interest rates on tax free bonds ranges between 7.3% to 7.5% per year. However, these rates are dependent on the ratings on bonds given by credit rating agencies.

    How to Invest in Tax Free Bonds?

    Investors can buy these tax free bonds either in physical format or demat form. The subscription period for investing in tax free bonds is open for a limited period of time within which you need to buy these bonds. An investor needs to furnish his/her Permanent Account Number (PAN), if the bonds are purchased in the physical format.

    Tax Free Bonds in India 2015

    In 2015, the government of India has permitted seven state owned companies to sell tax free bonds in India for the financial year 2015 for the purpose of raising an amount of Rs.40, 000. Listed below are the top seven tax free bonds offered by different companies in 2015:

    State Owned Companies Allocated Amount of Bonds
    National Highway Authority of India Rs. 24,000
    Indian Railways Finance Corporation Rs. 6,000
    Housing and Urban Development Corporation Rs. 5,000.
    Indian Renewable Energy Development Agency Rs. 2,000.
    Power Finance Corporation Rs.1,000
    Rural Electrification Limited Rs. 1,000
    NTPC Limited 1,000

    Who can Invest in Tax Free Bonds?

    The following categories of investors can invest in tax free bonds:

    • Qualified Institutional Buyers who have been defined under the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000.
    • Limited liability partnerships, partnership firms, trusts, co-operative banks, regional rural banks, corporates and other authorized entities.
    • Retail individual investors who include members of Hindu Undivided Family and Non-Resident Indians.
    • High net-worth individuals which include those investors whose risk appetite are low and can invest up to Rs.10 lakhs.

    Thus, the tax free bonds are ideal for modest risk appetite investors as well as high net-worth individuals who are looking for a steady source of annual income, and for those who can afford to lock-in their capital for longer tenures.

    News About Tax Free Bonds

    • Tax-Free Bonds from secondary markets a hit among Investors

      Expert investors are moving on to tax-free bonds in the secondary markets due to the higher rates of return that these instruments are expected to offer as compared to bank fixed deposits, especially in a scenario where the interest rates on these deposits are set to go down. These instruments offer around 2-5 per cent more as compared to fixed deposits. Several tax-free bonds of such nature are floating in the market with various state governments as well as central government issuing these bonds regularly.

      Bonds by government agencies like NABARD, HUDCO, NHAI are easily available in the secondary markets and offer an interest rate of 7-7.05 per cent.

      27th April 2015

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