It is common to see people always in search for investment options that offer them great financial returns. In India, Tax-Free Bonds are issued by the Indian Government for providing benefits to investors in the form of tax savings. These bonds come with the advantage of having zero tax deductions and has become a go-to low-risk investment option. This article aims to highlight the various aspects of Tax-Free Bonds.
Tax-Free Bonds are a kind of goods or financial products which are issued by a government enterprise. For example, Municipal Bonds. They offer an individual with a fixed interest rate and a low-risk investment avenue. Generally, these bonds are created with a long-term maturity that lasts up to ten years or more. The rules and regulations concerning Tax-Free Bonds are stated in Section 10 of the Income Tax Act of 1961. The money collected from these bonds is taken by the Government to invest in infrastructure and housing projects around the country.
Tax-Free Bonds are an excellent option for an investor who seeks to earn a fixed annual income from the interest generated from the bonds. An investor is also required to have their investment locked in for an extended maturity period of at the least ten years. Hence, these bonds are best suited for individuals who have a low-risk profile with the ability to afford a long-term lock-in period.
As defined by SEBI, qualified institutional investors may invest in these bonds as per the rules and regulations stated under the Disclosure and Investor Protection Guidelines. Limited Liability groups and Partnerships are also considered eligible to invest in Tax-Free Bonds. Other regular investors in these bonds would be entities such as co-operative and regional bans, trusts and corporate companies. Individuals such as HUF members, Non-Resident Indians and other individuals of high net-worths often opt for Tax-Free Bonds with the aim to diversify their investment portfolio.
The following are the critical features of Tax-Free Bonds. Some of these features are essential benefits that an investor is offered for being a part of a Tax-Free Bonds.
At the moment, these bonds offer a 6.5% rate of interest for its investors. This is relatively attractive once the tax exemption is also considered. A bondholder would receive interest on an annual basis. However, the rates of interest of Tax-Free Bonds are subject to fluctuations due to their relation to the current rate of government securities.
Exemption from Taxes
The income that is generated from a Tax-Free Bond in the form of interest is completely free income tax of any sort. This also includes the exemption from tax deducted at source as well. However, this does not translate into claiming the invested amount for a tax deduction. There, every bondholder is required to declare the interest they receive as income. Tax-Free Bonds offer a wide array of great benefits to its high tax bracket investors when compared to Fixed Deposits offered by banks.
Unfortunately, unlike debt funds, a bondholder cannot liquidate Tax-Free Bonds easily. The reason for this is that government bonds are generally long-term investments and come with more extended lock-in periods. Hence, this cannot be treated as an emergency fund.
The chances of defaulting on an interest payment are meagre as the government itself initiates these schemes. It is quite safe to invest in Tax-Free Bonds as they offer a fixed annual income and capital protection.
Tax-Free Bonds are issued using a demat account or in a physical mode, as well as trade in stock markets. Therefore, the interests generated through these bonds are entirely free of tax. However, the capital gain obtained from selling Tax-Free Bonds in stock markets is taxable.
It is in the nature of Tax-Free Bonds to have a very long lock-in period that lasts from 10 to 20 years. The invested amount cannot be withdrawn before the date of maturity.
The returns that are obtained from these bonds are largely dependent on the purchasing price as they are traded in low volumes with a limited number of buyers or sellers who are interested.
Investing in Tax Free Bonds
Tax-Free Bonds have the facilities for trading that permit an investor to trade bonds through a demat account or in a physical form. Availing the various investment opportunities offered by Tax-Free Bonds are simple and reap in high rewards. However, it should be noted that the subscription period for the investment would be open only for a particular period. An individual is required to submit their PAN while purchasing a physical format of these bonds.
Then, the investor may trade by applying, online or offline, when it is released to the public by the government. Whereas, if an investor applies for a bond post issuance, they may invest using a trading account. Therefore, this makes it different from trading shares in stock markets.
Redeeming Tax-Free Bonds
It is not challenging to redeem Tax-Free Bonds once the maturity tenure is over. Although, it is not possible for an investor to withdraw the money before the pre-determined maturity tenure. However, an investor in these bonds may choose to trade them on stock exchanges to another buyer or investor. It should be noted that the entity who sold the bonds initially would not be able to buy back the said bonds as well. The profit that is made from selling these bonds is deemed taxable under Section 112. Hence, the gains generated from selling the Tax-Free Bonds prior to a year is considered to be taxable as per the seller’s income tax slab. Trading these bonds after a year without indexation would attract a rate of 10% of long term capital gains. The tax would be raised to 20% after a year with indexation.
Tax-Free Bonds vs Tax Saving Bonds
It is common to be confused between Tax-Free Bonds and Tax Saving Bonds, or be considered the same. However, they are different, and the following are the crucial differences between the two.
|Tax-Free Bonds||Tax Saving Bonds|
|The Interest Income generated from these bonds is exempt from any taxes.||For Tax Saving Bonds, only the initial investment is exempted from taxes.|
|The rules and regulations regarding such bonds are stated in Section 10 of the Income Tax Act.||The rules and regulations regarding Tax Saving Bonds are stated in Section 80CCF of the Income Tax Act.|
|Tax-Free Bonds offer higher rates of interest when compared to those offered by Tax Saving Bonds.||They offer lesser rates for interest when compared to Tax-Free Bonds.|
|The investment limit for them is unlimited.||The investment limit is higher compared to Tax-Free Bonds. However, the exemption for the tax is only applicable for investments up to INR 20,000.|
|These bonds have a higher period of lock-in starting from 10 years.||They have vital buyback clause. An investor has the option to withdraw their investments after a tenure of five or seven years.|
Government Entities offering Tax-Free Bonds
There are quite a few public undertakings that offer and issue Tax-Free Bonds and are listed below.
- NTPC Limited and Indian Railways
- National Highway Authority of India
- Housing and Urban Development Corporation
- Rural Electrification Corporation
- Rural Electrification Limited
- Indian Renewable Energy Development Agency
- Power Finance Corporation