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  • Category: Investments

    What are tax free bonds and how their interests are paid?

    Do you want to know about Tax free bonds and the accrued interest from them? Check this ISC page to get a complete picture about it.

    I recently came across taxfree bonds. I found that these are giving somewhat more returns when compared to Fixed Deposits. By the name itself suggests that the interest income that is gained from the tax free bonds are exempted from income tax. As they are also traded in the secondary markets, can I buy these bonds directly from the secondary markets? If I buy them in the secondary market, how will the interest be paid? Will the interest be paid only for the holding period? How will I gain from taxfree bonds if I sell these bonds in the secondary market just before the interest payment date?
  • Answers

    6 Answers found.
  • Tax free bonds are long term bonds issued time to time by Govt undertakings like PSUs. Their interest is tax free. Interest is paid once in a year. Generally their tenure is in the range 10-20 years.
    As they are traded in market one can sell them at an opportune time.
    The rate in market fluctuates due to various economic and demand related reasons. So one should see the rate and find out how much will be the actual return to him so that a decision can be taken for buying the same from market.
    Basically for high net worth people who can park their money for a longer time it is a very good option for investment.
    One thing to be noted is if you get these bonds at the time of issue the interest rate is what is mentioned there but when you purchase from market you will get slightly reduced interest (about 0.5 %). So this factor is also to be considered when one is buying from the market.

    Thoughts exchanged is knowledge gained.

  • Bonds are issued when govt. is in need of the funding for long term projects or continuing the existing projects with infrastructure updates. Considering the projects are handled by govt. and they are not for profit ventures and their serving is to the state and people, they don't mean to give returns at par with the mutual funds or even FDs. However their interest rates are pegged at the other govt. tax free offerings. So usually PPF, NPS type of investment have similar rate as to that of bonds.

    Tax free bonds don't attract taxes. However your CA may require you to declare the investment in any assets including bonds to him for the documentation. Please do so.

    As for the interest. The interest being in between debt funds and the equity. And often this bond being long term investment. It's not recommended to keep your money parked here unless you are planning for future. Low interest is the issue here. So I think if you want interest and safety then other govt instruments are lot better. Bonds are good with low interest for parking funds which you don't want to touch for long term.

  • These are attractive options for investments as these are issued by Government organizations and offer a tax exemption on the money it makes. Under the Income-tax act 1961, section 10(15)(h), the government is allowed to issue safe, non-convertible bonds. The popular ones are NHAI(national highways authority of India), NTPC(national thermal power coroporation), HUDCO etc. The holding period would usually be 5 or 10 years and above.
    The only problems with tax-free bonds are its liquidity, you cannot quickly sell it in the market like shares or mutual funds. Most secondary market purchases happen when the primary offer is closed and the PSU tax free bonds are favoured in the secondary market transactions.

  • What it is : Tax free bonds, as the name suggests are long term debt instruments whose interest income is exempted from the calculation of income tax. These are generally issued by government backed authorities who raise funds for various infrastructure related projected initiated by government. Some of the entities who issue such bonds are Rural Electrification Corporation (REC), the Power Finance Corporation (PFC), National Highway Authorities of India (NHAI), HUDCO, NTPC, National Renewable Development Agency etc.
    Structure of the tax free bonds : The Tax Free Bonds are issued for fixed tenures such as 10 Years, 15 Years and 20 years. They used to pay a fixed coupon rate or rate of interest over a fixed tenure. The coupon rate is paid out on regular intervals, usually, semiannually and the principal amount is returned on maturity. The bonds can be traded in the secondary market and are secured and redeemable and non convertible in nature. Retail Investors, Qualified Institutional Buyers (QIBs), High Net Worth Individuals (HNIs) can subscribe to the bond issue.
    Generally bonds are listed within 15 days of closing of the issue. Generally, the allotment is done on first come first serve basis. Anyone who is interested in investing in the bonds can hold the bonds in demat as well as physical form.
    The coupon rate : The coupon rate that a Tax Free bond can offer depends on two factors. The first factor is the rate of interest that a government security (G-Sec) can earn at the time of issue. The coupon rate of the tax free bond can be a few points lower than the G-Sec of the same tenure. For example, if an issuer comes up with an AAA rated bond for a period of 15 years, the interest earned by a retail investor will be 0.5 percent lower than a G-Sec and 0.8 percent lower for all other class of investor. The other factor which influence the coupon rate is the rating of the issuing agency. Similarly a bond issued by a AA+ rated issuer will earn a little more than an AAA- rated issuer. Lower the rating of the issuing agency, lower will be the coupon rate.
    The tax angle : The interest income earned through these bonds are exempted from calculation of income tax under section 10 (15) ( IV) (h) of Income Tax Act 1961. However there are conditions under which the capital gains from such bonds will not be eligible for taxes exemptions are
    1. Capital gains on selling or transferring of the bonds in the secondary market. The tax rate will be applicable according to the income slab of the investor
    2. Capital gains through sale or transfer of the bonds within a period of 12 months from the issue of the bonds will be taxed. Capital gains beyond a period of 12 months will be taxed 10.3 percent
    3. There will not be any tax benefit on the principal amount and is applicable to TDS deductions
    Who gets the most tax benefit : The benefit of investing in the tax free bond is measured thorough effective rate of interest (effective yield) which can be calculated through formulae as below
    Effective yield = coupon rate / (1-tax rate)

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  • A bond is a fixed income instrument carrying a coupon rate of interest. It is issued for a fixed tenure. The interest earned from tax-free bonds is exempted from tax. Irrespective of the income slab one need not pay any income tax on the income obtained as interest.Some of the public undertakings that are issuing tax-free bonds are IRFC, PFC, NHAI, HUDCO, REC, NTPC, and Indian Renewable Energy Development Agency.

    The tenure of the bonds is generally will be 10 years, 15 years and 20 years. The interest will be paid annually as per the details provided at the time of purchase. The bonds can be sold during the tenure also, But when the bonds are sold the income earned will be taxed under capital gains.

    always confident

  • Tax free bonds are one of the most popular options for investment for high net worth individuals who have ample surplus for long time investments as these bonds are generally issued for a long tenure of 15-20 years.

    These bonds are generally issued by Govt PSUs and undertakings and their interest rate is also very attractive. A few years back their interest offerings were in the range of 9% but due to interest rates declining everywhere their interest rates are also lower today in the range 6-8%.

    These bonds are issued time to time by these Govt PSUs for their working capital or expansion programs and are backed by Govt. The interest of these bonds is tax free and is payable once in a year. As their interest is tax free they are a very attractive option for investment.

    One can subscribe to them when they are initially issued in market or purchase from the share market. While purchasing from share market one has to find out what is their interest payment date, their interest rate, date of maturity and present rate in the market. These things are necessary to find out what will be the return to the investor (known as yield) if he invests in them today. If the yield is satisfactory one can take a decision to buy them. As soon as you acquire them the interest will be payable to you as per the record date of payment of interest which means that if you have got them before record date, interest will be credited to your account.

    There are occasions when due to various global factors and sudden investment by international agencies in some of these bonds they quote in market at high prices and that is the time when the shrewd investors sell them and make money. Please remember such sale is subject to capital gain tax as per specified rates in income tax rules. So these are the things to keep in mind while selling these bonds when such opportunity arises.

    Knowledge is power.

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