A note on tax saving bonds

RBI issues tax-free ‘RBI Relief Bonds’ which offer 8.5% interest rate compounded every 6 months. The bonds are extremely safe and mature in 5 years. A special feature is that these can be pledged as securities in a bank for borrowing credit. RBI Relief Bonds can be sold to another party in the secondary equity market and this provides liquidity to the investor. The relatively small face value of Rs 1,000, vis-à-vis other types of bonds, provides additional liquidity as it simplifies the transferring process to a third party and provides flexibility to the investor in terms of choosing the fraction of the total bond investment to sell off.

Tax-saving bonds are one among the important tax saving options available to individuals. Interest incomes generated by them are tax deductible and this is over and above the Rs 1 lakh tax exemption investors can avail of under section 80C of the I-T Act. A disadvantage of tax-saving bonds is that the interest rates offered are not adjusted for inflation which, at current 10% level, can significantly erode the value of bond investments. The bonds are for individuals with low risk appetite, who are looking to primarily preserve income and earn returns on the same as a secondary goal. Tax-saving bonds are issued by RBI and organizations belonging to both public and private sectors.

The Union Budget for 2010-11 introduced infrastructure bonds to help finance infrastructure projects which usually take 3-10 years to complete. Resident Indian individuals and HUFs can invest in the bonds and get a deduction of maximum Rs 20,000 in computation of taxable income for the current financial year. This would enhance participation of retail investors in infrastructure financing. Individuals investing in tax-free infrastructure bonds can achieve a tax saving of Rs 2,000-6,000 per annum depending on the applicable tax slab. The bonds have maturity period of 10 years with a 5 year lock-in period with out without a buy back option from the issuing company.

Here is a brief look at some of the options available currently:

IDFC has issued (from 30 September) tax-saving infrastructure bonds of 10 year maturity and 8% rate to raise Rs 3,400 crores. The bonds are rated LAAA by ICRA, indicating highest degree of safety. This is the first public issue of tax-saving bonds by an infrastructure company. Investors can expect a few more in the short -term future owing to growing spending on infrastructure development.

RBI issues tax-free ‘RBI Relief Bonds’ which offer 8.5% interest rate compounded every 6 months. The bonds are extremely safe and mature in 5 years. A special feature is that these can be pledged as securities in a bank for borrowing credit. RBI Relief Bonds can be sold to another party in the secondary equity market and this provides liquidity to the investor. The relatively small face value of Rs 1,000, vis-à-vis other types of bonds, provides additional liquidity as it simplifies the transferring process to a third party and provides flexibility to the investor in terms of choosing the fraction of the total bond investment to sell off.

The finance ministry has approved public issue of tax-free, secured bonds of Rs 1,000 face value by the Indian Railways Finance Corporation (IRFC) for raising Rs 3,080 crores in the financial year ending March 31, 2011. The bonds would yield interest rates in the range of 6-7.25% per annum, depending on the size and maturity of a tranche. IRFC bonds are a lucrative option for investors in the 30% tax bracket. The bonds are guaranteed by the government and therefore are as safe as bank deposits. Return generated by the bonds are much higher than that of bank deposits and hence are superior to bank deposits. Returns of 6-7.25% in taxable instruments are approximately equivalent to 9-11% returns in taxable instruments for an individual in the 30% tax bracket. Bank FDs are currently offering 7-7.75% depending on maturity.

Capital gains tax-saving bonds are not tax-saving bonds per se and are used to save capital gains tax only. Long-term capital gain generated by assets like property and gold can be invested in Sec 54EC tax-saving bonds having lock-in period of 3 years. The investor has to pay taxes only on the interest income generated by the bonds and not on the entire amount received as capital gain.

Quick Overview of Tax Saving Bond options available currently: