TAX FREE BONDS - AS SMASHING AS DANIEL CRAIG?

By Ruma Dubey

Last year, this time, fixed deposits were the best possible investment option available what with interest rates on the upward spiral and IPO markets drying up completely. This time around, as we end 2012, the IPO markets have woken up and is showing existence of life. And the fixed deposits, well, they are not as good as they seemed at the end of 2011, what with interest rates now expected to go down.

And like last year, this time around too, bonds, seem like a good option. This is the time when companies launch their tax saving bonds and they seem like a good and safe bet at the moment, given all the other options.

India has a high savings rate and people tend to constantly be on a look out for better investment avenues. People are sitting on money, they need options. And in these tumultuous times, when there is no appetite for risk, NCDs are fast emerging as the safer havens. In 2011, 5 PSUs raised money through issue of tax saving bonds or NCDs and investors have stood to earn anywhere around 12 to 16% interest. This time around, there seems to be a skyfall of bonds – around 10 companies have come to the marquee with their bonds.

Tax free bonds, as the name suggests, offers a tax free on the interest earned. Something akin to the money which we invest in PPF account, the interest income remains tax free and it is an instruments mainly to save tax too! After taxation, the yield which one gets on seemingly higher looking interest rates, is almost same as that money earned in these bonds, which on face value might be giving you a lesser interest rate.

The tax free bond issue of Power Finance Corporation (PFC) closed on 21st Dec and its 15 year (Series 2) bonds were comparable to a 11.37% pre-tax return earned on other fixed income instruments, assuming the highest tax bracket of 30.9% for retail individuals. Prior to that, REC’s tax free bond issue closed on 10th Dec its 15 year (Series 2) bonds were comparable to a 11.40% pre-tax return earned on other fixed income instruments, assuming the highest tax bracket of 30.9% for retail individuals. Compared to these, the post-tax income earned from Fixed deposits comes at a much lower rate and works to around 8.5% in most of the offerings.

Compared to last year, the tax free bonds are also coming at much lower rates. Like PFC’s tax free bonds, which were offered in 2011 was at 8.3% pa for 15 years tenure and 8.2% pa for 10 years tenure. And this time, in 2012, 15 years tenure pays 7.86% pa and 10 years at 7.69% pa. But this will only go down as interest rates come down but remember, it will still earn you more than a FD.

Also tax free bonds are more liquid, where you can sell it in the secondary markets while breaking of an FD, before the tenure, will invite you a penalty. Bond prices move in exact direction to interest rates – when rates are up, bond rates are down and when interest rates are down, bond rates go up. As we all know, in the coming months, interest rates are only expected to come down and that means, unlike a FD, which moves in tandem with interest rates, tax free bonds will earn you better. Another point in favour of tax free bonds is that it does not have TDS. In FDs, when your interest income goes above Rs10,000,a TDS is cut  but here, in tax free bonds, there is no TDS.

Tax free bonds score higher in all aspects, except one – capital gains. As per provisions under section 2 (29A) of the Income Tax Act, read with section 2 (42A) of the Act, a listed Bond is treated as a long term capital asset if the same is held for more than 12 months immediately preceding the date of its transfer. Under section 112 of the said Act, capital gains arising on the transfer of listed Bonds shall be taxed @ 10% without indexation. And short term capital gains tax is also applicable as per your tax slab.

The bond issue from India Infrastructure Finance Co Ltd (IIFCL) has opened today, 26th Dec and it is offering 7.88% and 7.72% for 15- and 10-year bonds, same as what REC had offered. IIFCL has come up with one more tenure – 20 years and is offering 7.9% interest. But the most eagerly awaited issue is from Indian Railways and that is expected to come sometime in January.

At a time when we are expecting interest rates to start coming down, tax free bonds are a safer haven, with more earning propensity. And if you come into the higher taxation slab, are a HNI, tax free bonds is then a must!