Tax-free bonds: Not just a tax shelter

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For investors in the highest tax bracket, the effective yield is high. (IE Photo) For investors in the highest tax bracket, the effective yield is high. (IE Photo)
SummaryFor risk-averse retail investors, tax-free bonds of PSUs provide an opportunity to earn good returns.

Tax-free bonds launched by public sector companies are an ideal instrument for risk-averse retail investors. After Rural Electrification Corporation and Hudco, state-owned India Infrastructure Finance Company (IIFCL) has now launched a public issue of tax-free bonds to raise Rs 2,500 crore, with tenures of 10, 15 and 20 years. The issue will be open for subscription till October 31.

Under tax-free bonds, while the investor does not get any tax exemption under Section 80C of the Income Tax Act, 1961, the interest accrued is completely tax-free under Section 10(15)(iv)(h).

Only public sector companies can issue such tax bonds. Retail individual investors, qualified institutional buyers, corporates and high net-worth investors can invest in the tax-free bonds in varying proportions. Investors applying for an amount aggregating up to R10 lakh across all series of bonds in each tranche issue will come under the retail individual investor category. The same retail investor can also apply again in the next tranche or in the issue by other companies’ tax-free bonds.

Earlier this financial year, REC mobilised R3,500 crore through such bonds. Hudco, whose tax-free bond offering is currently open for subscription, is looking to garner R4,809 crore.

In its red herring prospectus, IIFCL had said that it plans to raise R8,171 crore through tax-free secured, redeemable, non-convertible bonds of the face value of R1,000 each for the current financial year. The company has now decided to restrict the issue size to R2,500 crore in the first tranche.

For retail investors, IIFCL, in the first tranche of the bond, is offering rates of 8.26% for 10-year paper, 8.63% for 15-year paper and 8.75% for 20-year paper. So, it makes sense for you to lock-in your money for a long period as this is not only the highest possible rate but also the interest accrued is completely tax-free.

For investors in the highest tax bracket, the effective yield is high. However, for qualified institutional investors, corporate and high networth investors, the rates are marginally lower — 8.01% for 10-year bond, 8.38% for 15-year bond and 8.50% for 20-year bond. Financial planners say long-duration bonds reduce the re-investment risk and, as interest rates may come down in the long term, it is better to lock-in with the high rates that these tax-free bonds offer.

Icra has assigned a credit rating of AAA to the IIFCL bonds. Instruments with this rating are considered to have the highest

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