What are Tax-Free Bonds?

The choice of investment is endless when it comes to investing for Indian investors. One can choose from monthly, quarterly, half-yearly, annual, and schemes that offer taxable and non-taxable returns. Regardless of this, it is essential to select the right investment plan to enjoy tax-free benefits. Tax-free bonds are helpful for high-net-worth investors.

What are Tax-Free Bonds?

A tax-free bond is an income certificate with a particular interest rate issued for a specific tenure. As the name suggests, the investor receives exempt from paying tax. In simple words, the investor, regardless of the income slab, does not have to pay any tax on the income earned in the form of interest from the bonds. A few of the public undertaking companies such as HUDCO, NHAI, IRFC, PFC, and Indian Renewable Energy Development Agency issue tax-free bonds. The tenure for these bonds varies between 10 and 20 years. The companies also list them on the stock exchanges to provide the chance for the investors to exit before the completion of the tenure.

Tax Status

The interest acquired by the investor is immune from tax. However, the individual may not enjoy the tax benefit on the invested amount on the bonds. Furthermore, the investor is not eligible for TDS on the income. However, eligibility for TDS is active for the application money.

Tax-free bonds are available on stock exchanges, and trading takes place using demat accounts. If the individual chooses to transfer the capital gain on the bonds, then he or she will have to pay tax for the same. Additionally, if the individual chooses to hold the tax-free bonds for less than a year, capital gains earned by selling the bonds are taxable according to the tax rate described by the investor. If the holding is greater than a year, the tax rate is at 10.3%.

Advantages

Tax-free bonds are popular for investors who are parking vast sums of money. Tax-free bonds are safe because government institutions issue the same and arrive with high-grade ratings. Additionally, the pre-tax yield is high for the high-income tax slab category. Although these bonds are low risk, the pre-tax yield is high. As the returns are tax-free and work backward, the post-tax profits are high. Therefore, it enables high-risk profile investors to enjoy tax-free benefits and ensure the safety of their investments.

For instance, an individual who is paying 30.9 % as tax can choose the taxable investment with a yield of 8.68 %. The taxable investment yielding at this rate will fall to 6% post-tax of 30.9 %.

How Do They Work?

The interest offered on the tax-free bond depends on the government securities and the prevailing condition at the time of the issuance. After setting the value, it remains the same for the entire tenure. The interest rate offered is dependent on two things – ratings of the issuer and whether the investor is a high net worth.

Interest Rates

Interest rates for tax-free bonds with a rating of AAA will have 0.5 % lower when compared with that of the G-sec rate and 0.8 % lower for other investors. For bonds with an AA+ rating, the interest rate will be 0.10 % higher than AAA issuers. For AA and AA-, the interest rate is 0.20 % higher than AAA issuers.

Disadvantage

The only disadvantage of tax-free bonds is long-term investment. Therefore, it is essential for an investor to carefully think about the time frame before opting for tax-free bonds. Choosing it is only helpful when the individual decides not to use the funds for the stated period.