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Inflation Indexed Bonds are a welcome option for a long-term conservative saver. Find out how the taxation works before you plunge into the product. The returns will vary based on your tax bracket. It will work well as a retirement savings tool for those in the lower tax bracket
Inflation Indexed National Savings Securities-Cumulative (IINSS-C) securities are being launched by the Reserve Bank of India (RBI) in the backdrop of announcement made in the Union Budget 2013-14 to introduce instruments that will protect savings from inflation. Interest rate on these securities would be linked to final combined Consumer Price Index [CPI (Base: 2010=100)]. Interest rate would comprise two parts - fixed rate (1.5%) and inflation rate based on CPI and the same will be compounded in the principal on half-yearly basis and paid only at the time of maturity. E.g. CPI of 11.24% in November 2013 means you can expect to get 12.74% pa assuming inflation stays at the same level. The minimum and maximum investment per annum is Rs5,000 and Rs5 lakh respectively. The tenor is fixed at 10 years.
Taxation:
Do not misinterpret the taxation of IINSS-C; there are conflicting media reports on tax issue. Some media reports talk about considering payment as capital gains, which will lower the tax rate. But, ignore such misinterpretation and calculate tax payments based on your tax slab. There is no special tax treatment of inflation indexed bonds. These will be treated as normal bonds and taxed.
Tax treatment on interest and principal repayment would be as per the extant taxation provision. Tax will be levied on the interest as per your tax bracket, which is inline with bank FD taxation. INSS-C is suitable for those in lower tax bracket (up to 10%). It is a better option than bank fixed-deposits (FD). IINSS-C may work out well for those in 20% tax bracket if inflation remains at current level for much of the 10 year tenor. Those in highest tax bracket will do better with tax-free bonds.
One drawback with cumulative FDs is that you have to pay tax on the interest that you don’t receive in hand. You get the interest only on maturity of the cumulative FD, but tax on the accrued interest is payable for each financial year in which it accrues. The same will be an issue with IINSS-C. The government will earn the tax payment on accrued interest without paying you any interest for 10 years. The higher the inflation, the higher the accrued interest and hence more tax will be collected. If the inflation dips, the government will benefit by having to pay lower interest on product maturity. RBI circular specifies that issuance of non-cumulative inflation indexed bonds for retail investors will be examined in due course. It will have to be seen if and when non-cumulative option really comes.
IINSS-C will give variable income, which is cumulative. It means income is earned and re-invested as per the product feature and conditions, once income is accrued it is taxable in the hand of the individual as per tax bracket. Income tax offers flexibility of cash or accrual basis, but cash basis will not work practically since all interest will be taxed in one single year and hence it will be offered for tax each year. Income tax does offer both options to the assessee in case of accrual products, but it should be uniform and not instrument wise.
If an assessee is following mercantile system, then he/she will pay tax on accrual interest either by way of advance tax or self-assessment tax while filing return. If assessee is following cash system in respect of interest income, then entire income to be shown at the time of final receipt and tax to be paid when money received. For ‘income from other sources’, normally one pays tax on the basis of mercantile system even though they are not receiving actual payment. From accounting principle point of view and direct/indirect taxation point of view, mercantile system is better for majority of cases. If Form 26AS shows TDS and correspondingly assessee is not showing income, IT officer can question why income is not shown and assessee need to face issues to explain and prove accounting system. Similarly, if one is declaring income at the time of receipt of interest (at maturity) at the end of 10 year, there will be practical difficulties to claim tax credit (i.e. credit of TDS of all the previous year to be clubbed in the year of receipt of income). At present, income tax return does not have provision to give reconciliation, so practically, mercantile system is better.
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