TAX FREE BONDS - THE 'BEST' FLAVOR OF THE SEASON!
By Ruma Dubey
Tax free. These words always sound like heaven, better than the big announcements of “SALE” and for the financially inclined; it’s like the Big Bazaar “Sabse Saste 5 din” offer. This is the time of the year when the market gets flooded with tantalizing tax free offers and this time around too, there are some good offers on the block, especially from REC and Hudco.
Like last year, this time too, given the fact that interest rates have remained firmly up, these offers are being termed as “great” especially on the longer tenures – 10 and 15 years as the interest rates being offered are high and thus the yields being offered are also high. On an average, we are seeing offers of around 12% pre-tax returns and around 8.2% post-tax if you are in the 30% tax bracket and over 9.5% for those in the 20% tax bracket. And that is a very good deal! This is much better than the returns earned on bank FDs which give a post-tax return of around 6% to 6.95% in 20% tax bracket and 5.9% to 6.05% in 30% tax bracket.
And exactly like last year, this time too, PSUs continue to take the lead in issuing tax free bonds. The ‘season’ was flagged off by two offers - National Highways Authority of India (NHAI) and Indian Railways Finance Corporation (IRFC). As per data put out by SEBI, public issue of NCDs and tax-free bonds, till end of Feb’14 mobilised Rs.33,842 crore – this is almost double the money collected in FY13. Tax-free bonds offered by IRFC, Power Finance Corporation (PFC) and NHAI together collected more than a third of the mobilisation or 11,739.2 crore. In FY12, there was a record collection of Rs.35,611 crore and this fiscal, FY14 promises to surpass even that record! FY14, till date has seen 24 NCD/bond offers hitting the market, the highest ever from institutions and the good news is that each and every one of them was fully subscribed.
Here, in bonds of HUDCO, the interest does not attract TDS nor do the bonds attract wealth tax. Also, the bonds do not have any lock-in period. It is offering higher coupon of 15 basis points for 15 year bonds vis-a-vis the offer 3 months back for similar bonds (8.83%), as 15 year yields have hardened. The 20 year bonds however are offering 5 basis points lower yields – 8.96% now as against 9.01% in December 2013. The 15 year (Series 2) bonds, carrying the highest coupon rate, are comparable to a 13.00% pre-tax return earned on other fixed income instruments, assuming the highest tax bracket of 30.9% for retail individuals. This is very attractive rate as currently no bank is offering double digit interest rates on long term deposits.
On the other hand, REC is offering 8.88% pa coupon for both 15 year period. Although the current offering is 17 basis points higher than its September issue from the same company (8.71% offered for 15 years), it is lower than HUDCO’s bonds. IRFCL’s 15 year (Series 2) bonds are comparable to 12.85% pre-tax return earned on other fixed income instruments, assuming the highest tax bracket of 30.9% for retail individuals.
If one compares them with a Fixed Deposit plan, two things stands out – firstly the interest earned on FDs is taxed while that on these bonds is not. Secondly, the average rate of interest offered by FDs on the maximum 5 year tenure is around 10% and that too will attract tax. But if you have an FD which offers you yield of 11.8 to 11.9% tax free , then it would be comparable. But obviously, no one is offering such yields on FDs. With interest rate cycle at currently the highest point on the curve, these long term tenure bonds thus offer good returns.
The allotment is on a first-come-first-serve basis. The interest coupon depends on the maturity and category of investor. Both bonds are to be listed on both the NSE and BSE, wherein on listing, investors can sell bonds they were allotted in the secondary market.
These bonds are best for those having surplus of Rs.1 lakh and above to invest. Here investors are looking at a return of 8.15% every year for ten years, or 8.3% every year for 15 years. Only investors having a long term horizon can invest in these bonds. Yes, it is better than parking funds in fixed term deposits which attract tax. If you are looking at the bonds like a stock, where you hope to make a killing in listing, be careful as these tax free bonds, like stocks, will attract tax. Any gains from sale of these bonds will be treated as capital gain and will be taxed depending on the holding period of the bond.
Tax free bonds are good only for those with a long term horizon. It is best to hold these bonds till maturity; it is only then that you will enjoy the “tax free” benefit on the higher interest rates.