Tax Free Bonds

These bonds are mostly issued by Central government enterprises and pay a fixed coupon rate (interest rate). As the proceeds from the bonds are invested in infrastructure projects, they have a long-term maturity of typically 10, 15 or 20 years. There is no upper limit on the investment amount.

The income by way of interest on these Bonds is fully exempt from Income Tax and shall not form part of Total Income as per provisions under section 10 (15) (iv) (h) of I.T. Act, 1961.As the interest income is Tax Free, there is no deduction of tax at source (TDS) from the interest, which accrues to the bondholders.

The coupon (interest) rates of tax-free bonds are linked to the prevailing rates of government securities. So these bonds become attractive when the interest rates in the financial system are high. In some of the issuances, retail Individual Investors (Individual & HUF) get higher interest rates. The advantage of higher interest rate can be availed, even if an Individual investor invest through secondary bond market.

The interest on these bonds is paid annually and in some issuances it is semi-annual and credited directly in the bank account of the investor.

Since tax-free bonds are mostly issued by central government-backed companies, the credit risk or risk of non-repayment is very low.

The investor can hold the bonds either in demator in a physical mode. It is preferable to hold the bonds in a demat form, for convenience and ease of trade.

The tax-free bonds get listed and then traded on the secondary Bond Market to offer an exit route to the investors. The quote on the exchange will be a summation of : Face Value +/- Premium/discount + Accrued interest.Investors can buy and sell these tax free bonds to take advantage of interest rate cycle. Though the interest earned on these bonds is tax-free, but any capital gain from sale in the secondary market is taxable. Short-term capital gains from sale of tax-free bonds on exchanges are taxed at the normal rate, while long-term capital gains are taxed at 10% without indexation and 20% with indexation, whichever is lower. By indexing, you adjust the purchasing price with annual inflation.

Tax-free bonds are suitable for investors looking for a steady source of income annually . Generally an investor, who is into higher Tax bracket of 20% and above should invest in these instrument.

These bonds however, do not provide any additional tax benefits. (Investment in these bonds will not have Tax benefit under Sec 54EC)

The interest earned on bank FDs and other normal bonds are added to the income of the investor and taxed as per the income-tax slabs. As interest earned from tax-free bonds are not taxed, investors in higher tax brackets mostly earn a better post-tax return than from FDs. Majority of the bonds are secured in nature. Whereas the Bank FD is not secured beyond Rs.1,00,000 (One lakh).

We offer the service of Buying and selling of Tax free Bonds in secondary Debt Market. Please feel free to call on our office for two way quotes.