Tax free bonds are back. First Tax Free bonds 2015 will be launched by NTPC. NTPC tax free bond will be available at the interest rate of 7.63%. The issue subscription opens on 23rd September 2015. Apart from NTPC other companies like NHAI, IRFC, HUDCO, PFC and REC will be launching tax free bonds in 2015-16.
Tax Free Bonds
Tax free bonds are debt investment instrument. This bond are mainly issued by non –government or quasi-government institute to raise a money from the public. Tax Free bonds are secure as it is partially backed by the government. One can invest in this bond by filling up initial subscription offer. Once these bonds are listed investor can buy and sell this bond through the stock exchange.
Tax on Tax Free Bonds
Tax free bond is document security against money borrowing given to issuer (Government or PSUs). Issuer or borrower is bound to pay fixed rate of interest (coupon rate) against this bond till the maturity. Interest income earned from tax free bond is exempted from taxation u/s 10 of the Income Tax Act, 1961. That’s why these bonds are called as Tax free bonds.
Interest income earned on this tax free bond should be disclosed in income tax return as an exempted income.
Redemption of Tax Free Bonds
Tax-free bonds come with lock-in period of 10 to 20 years. However, these bonds will be listed on the exchange and you can sell them to another person. If you are selling this bond before maturity period, you will not get coupon interest rate.
Capital Gain on Tax Free Bonds
Suppose you purchased NTPF tax free bonds which opens on 23rd Sept, 2015 at the face value of 1000 Rs. After purchasing this bond you are selling fund before one year period at Rs 1100, the gain arising from this transaction will attract capital gains.
Tax Free Bond vs Fixed Deposit
Let’s try to compare tax free deposit with fixed deposit. Let’s assume that you are planning to invest in NTPC tax free bond in Sept 2015, with a coupon rate of 7.53 % for 15 years.
The post-tax return of NTPC tax free bond will be 7.53%. The effective yield for 20% tax slab will be 9.48%. If you are in 30% tax slab effective yield will be 10.65%.
Now suppose if you invest in fixed deposit for 5 years with the interest rate of 8%. The effective yield for 20% tax slab will be 6.4%. If you are in 30% tax slab effective yield will be 5.6%.
Therefore we can say that in the 20 and 30 per cent tax slab, the tax-free bonds make better sense compare to fixed deposit.
Tax Free Bond vs Other Investments
Should You Invest in Tax Free Bonds?
Tax Free bond is very good investment option providing consistent tax free return till maturity, however, longer maturity period of the tax free bond is limiting factor. Investing in such a long term investment option is advisable only if you have surplus money for investment. Tax free bond is less liquid and traded seldom in the secondary market. Before investing make sure that this investment option fits well with your financial goal.
As per me, you should not invest in tax free bonds. If you are risk adverse investor than also try to look for other investor-friendly options like PPF or Sukanya Samriddhi Scheme.
Do you still want to invest in Tax free bonds?