TAX FREE BONDS - THE "VAZIR" OF DEBT STREET

By Research Desk
about 4 years ago

 

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 most of the tax free bonds which had opened during end of 2015 received an overwhelming response.

Today, the tax free bond of IREDA or Indian Renewable Energy Development Agency opened and within the first half an hour itself, the issue was 52% subscribed.

IREDA is a PSU, an NBFC and promotes, develops and extends financial assistance for renewable energy and energy efficiency /conservation projects.

The Bond is offering a coupon rate of 7.74% for retail investors, depending on the tenure. The annual interest rate works out to 7.53% for 10 years, 7.74% for 15 years and 7.68% for 20 years. The interest rate is 0.25% lower for HNIs, QIBs and corporate subscribers.  40% of the issue is reserved for retail investors. Each bond is priced at Rs.1000 and minimum investment has to be for 5 bonds of Rs.5000. The upper limit is Rs.10 lakh.

One can apply to this bond both in demat as well as physical form. It will be listed on the BSE and will attract capital gains tax on exit through secondary market.

When we say “tax-free” what it means is that no tax is to be paid - no TDS on interest like the way FDs of companies attract.

If we decide to look at yields – for those in the 30% tax bracket a 10 year tenure bond will give a yield of 10.90%, 15 years will give 11.20% and 20 years will give 11.11%.

For those in the 20% tax bracket – 10 year yield will be 9.48%, 15 years will be 9.75% and 20 years will be 9.67%.

And for those in the 10% tax bracket, 10 years yield will be 8.39%, 15 years will be 8.63% and 20 years will be 8.56%.

The price of the bond, which is the face value of the bond is inversely proportionate to the yields. Imagine the price and yield sitting on a see-saw. When price goes up, yield will come down and when price goes down, yield will come down. This is probably the most simplistic way of understanding this concept.

Bonds are traded in the market unlike a fixed deposit, which is why yields and interest rates need to be taken into account. When bonds are traded in an open market, yield will be the profit which you make on the purchase of bond. Thus when bond prices rise, yields will fall and that will make purchasing the bond in the open market much attractive as the face value would have got adjusted upwards to adjust the lower yield.

Based on this, clearly, those in the higher tax bracket – 20 and 30% tax, will be better off. For 10%, FDs would be a better option as there the yield would be higher.

But for all investors, better to first invest in PPF and it offers a higher interest rate of 8.70% - tax free and then it left with surplus funds, invest in these PSU bonds.

Remember, if you are looking at investing in these tax free bonds, do so immediately as based on the response today and that for other bonds, it would be no surprise to see this bond go for a pre-close, much before the official close date of 22nd Jan. And also remember, some more PSU tax-free bonds are in the offing before 31st March.

 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.

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