Money Matters : TAX FREE BONDS – The Tax Payer Wins … For Once
On Dec 05, 2013
Budget 2013 allowed 12 state-owned Public Sector Units and the National Housing Board (NHB) to garner Rs.48,000 crores cumulatively through tax-free bonds. India Infrastructure Finance Company, HUDCO, Rural Electrification Corporation, PFC and NHPC have already raised Tax Free Bonds in the past few months.
Tax free bonds have been introduced by the government to give Public Sector Units access to low cost funds for infrastructure development. The investor, in this case is assured of tax free income -the interest income not being clubbed with taxable income unlike Fixed Deposits or other Bonds and debentures. The investor is also assured of liquidity as the Bonds are listed in the Stock exchanges and can be traded. Since a lot of bonds have been issued and also significant issues are being planned you will see more trading and liquidity in the bonds issued and you should be able to sell the bonds in the stock market should you require urgent cash. The interest earned on Tax Free bonds is not cumulative meaning there is an annual pay out of interest.
Two tax free bonds will open for subscription on 2nd and 3rd of December. National Thermal Power Corporation (NTPC) with a Tax Free Bond issue of Rs 1750 crores and Housing and Urban Development Corporation Ltd. (HUDCO) with 2439 Crores. Both the bonds are backed by the Government of India. HUDCO has a credit rating of AA+ which indicates high degree of safety and low credit risk. NTPC is rated AAA which means it has highest degree of safety and lowest credit risk. The difference in interest is Rs 100/Rs 1,00,000 investment per year. So if you invest Rs 1,00,000 in NTPC for a 20 year tenor you will receive Rs 2000 less over 20 years than if you invest in HUDCO. So you might as well stick to NTPC since it has a higher credit rating and it is the largest power generation company in India.
Strategy for Tax free bonds:
It is advisable to have an exposure to Tax Free Bonds for the simple reason that the income falls outside of the taxman’s net. Always aim to increase your tax free income by investing in a combination of Public Provident Fund and Tax Free Bonds. Income from fixed income instruments like Fixed Deposits, Bonds and Debentures will all have to be clubbed along with your taxable income. So when Tax Free Bonds allow you to legally earn tax free income it is better to switch part of your FD’s, Bonds etc into high yielding tax free bonds. This way you reduce your taxable income for the next financial year as well. In all probability Tax free bonds will be issued only till the next year and the government will in all likelihood stop issuing these bonds as they reduce the overall revenue for the government. So reap the benefits while they are around.
If you are in the 20 % or 30 % tax bracket then allocate as much money as possible to tax free bonds. You can close short term FDs earning less than 9 % [if pre closure penalty is not applicable] and invest the proceeds in Tax free bonds. If you have already invested in taxable bonds or previous tax free bonds [at rates less than 8%] you can sell them in the secondary market and convert to high yielding bonds of NTPC or HUDCO.
The overall strategy must be to improve post tax return on investment. Tax free bonds do just that. The grand daddy in this category is Public Provident Fund which gives a return of 8.7 % tax free with the power of compounding thrown in as an added icing on the investment cake. Mix it will the plethora of tax free bonds on offer and those which are going to be issued in the next few months, and you will have a big chunk of tax free income. If you convert your low yielding FD’s and bonds then you lower your taxable income for the next financial year as taxable interest is converted to tax free interest.Finally you can score one up on the taxman and have the last laugh.
MORE TAX FREE BONDS ON THE ANVIL:
In case you do not have funds to invest now, do not worry. You will be spoilt for choice as four more Tax Free bonds are scheduled to hit the market in the next 2-3 months. In all likelihood with the RBI hinting at Consumer Price Index as the base for monetary policy there is every chance that interest rate on these bonds may exceed 9 %.
The National Housing Bank (NHB) will raise Rs 2,100 crores in tax free bonds. National Highways Authority of India and Indian Railway Finance Corporation (IRFC), the financing arm of the Railway Ministry is also planning to raise funds through tax free bonds. NHAI is likely to raise Rs 5000 crores and IRFC is looking to raise Rs 10,000 crores. IIFCL has already raised around Rs. 4,200 crores out of Rs. 10,000 crores it has been allowed to raise from tax-free bonds this financial year.
Final note of caution: Please remember that Tax Free Bonds should not be confused with Tax Saving Investment under Section 80C which allows up to Rs. 1,00,000 to be deducted from your annual income. Ensure that you have funds available for availing investment in Section 80 C for the financial year 2013-14 for tax saving before you invest in Tax Free Bonds.
Editor's Note : Since the article, NTPC bonds has been oversubscribed more than 3 times its issue size on day 1. The NTPC bonds issue is likely to be closed this week.
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