A bond is a debt instrument which is used by mostly public companies to raise funds for their new projects or ongoing projects. The money can be directly raised by issuing bonds to the investors rather than going to bank for loans.
A fixed interest also known as 'coupon' for a fixed time period is being given by these companies to the investors.
After the maturity i.e. the defined for which the money was borrowed by the companies ends, the principal amount has to be returns to the investors. During the tenure of the bond, interest is given on monthly or, half yearly, quarterly or yearly basis.
What are tax free bond?
As the name suggest, interest earned on tax free bonds are tax free, irrespective of the income slab of the customer need not to pay any taxes on the income earned from tax free bonds.
Some of the public undertakings who issue bonds to raise money are IRFC, PFC, NHAI, HUDCO, REC, and NTPC.
The tenure or the term of these bonds is mostly 10 years to 20 years. They are listed on stock exchange post the issue to provide easy exit for the clients.
Any profit generated from sale of these bonds from stock exchanges is liable to tax. If the holding period is less than 12 months, the gain will be taxed as per income slab of the client. If the holding period more than 12 months, the tax applicable is 10.30% and no indexation benefit is provided.
Who is eligible to invest in tax-free bonds?
- Retail Individual Investors (RIIs) - Including members of Hindu undivided family (HUF) and Non-Resident Indians (NRIs).
- High Net-worth Individuals (HNIs) - who have a low-risk appetite and can, invest up to Rs. 10 lakhs.
- Qualified Institutional Buyers (QIBs) - who have been defined under the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000.
- Corporate, trusts, co-operative banks, regional rural banks.
Tax-free bonds are hugely popular with HNIs because they allow parking a huge lump sum at one place. They are perceived to be relatively safe as they are primarily issued by government institutions and carry high investment grade ratings. Also, the effective pre-tax yield is high for those in the higher income slab.
How Tax Free Bonds works:
The interest that an issuer can offer to investors depends on the yield of government securities prevailing around the time of issuance. Once set and offered, it will remain fixed for the entire tenure. The interest rate will depend on two factors - One, on the ratings of the issuer and secondly, whether the investor is a retail or a high net worth investor.
For tax-free bonds rated AAA, the interest rate for retail investors will be 0.5 per cent lower than the G-sec rate and 0.8 per cent lower for all other investors. For tax-free bonds rated AA+, the interest rate will be 0.10 per cent higher than AAA-rated issuers and for tax-free bonds rated AA or AA-, the interest rate will be 0.20 per cent higher than AAA-rated issuers.
Tax free bonds may not be an ideal investment to create wealth its primary objective is to save tax.
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