Tax-free bonds in India present a unique investment opportunity, particularly for those seeking tax-efficient income. These bonds, issued by government-backed Public Sector Undertakings (PSUs), offer tax-exempt interest, making them highly attractive to a wide range of investors. In this blog, we delve into the workings, benefits, and considerations of investing in tax-free bonds in India.
How Do Tax-Free Bonds Work?
Tax free bonds function similarly to regular bonds, with one major difference – the interest earned on these bonds is exempt from income tax. When you invest in a tax-free bond, you receive periodic interest payments (usually annually) and the principal amount is returned to you at maturity. The absence of tax on the interest means that the investor receives the full interest amount without any deductions.
For example, if you invest ₹100 in a tax-free bond with a 6% interest rate, you will receive ₹6 each year. In contrast, if this were a taxable bond and you fall into the 20% tax bracket, ₹1.2 would be deducted as tax, leaving you with only ₹4.8 as post-tax interest.
Redemption and Secondary Market Trading:
Tax-free bonds are generally long-term investments that cannot be redeemed before maturity. However, they offer liquidity through the secondary market, where they can be sold. It is important to note that selling these bonds before maturity may result in capital gains tax, depending on the holding period and applicable tax laws.
Tax Exemption Under Section 10(15):
The interest earned on tax-free bonds is exempt under Section 10(15) of the Income Tax Act. This section specifically covers certain bonds issued by government-backed PSUs, granting them tax-free status.
Issuers of Tax-Free Bonds:
Not all bonds issued by government-backed PSUs are tax-free. The eligibility for tax exemption applies only to specific issues. Here are some prominent issuers –
● National Highway Authority of India (NHAI) – NHAI, under the Ministry of Road Transport and Highways, is responsible for national highway development. NHAI tax-free bonds have had maturity periods from 10 to 20 years, offering interest rates between 7% and 8.5%.
● Rural Electrification Corporation (REC) – REC, a Maharatna company under the Ministry of Power, provides financial assistance and advisory services to power companies. The REC’s tax-free bonds issued in 2015 had maturity periods of 10, 15, and 20 years, with interest rates ranging from 6.9% to 7.5%.
Who Should Invest in Tax-Free Bonds?
Tax-free bonds are ideal for investors seeking stable, long-term income, particularly senior citizens and retirees. Their long tenure (typically 10+ years) and high credit ratings (usually AAA) make them suitable for low-risk investors. These bonds are also attractive to those in higher tax brackets due to the tax-exempt interest.
Benefits of Investing in Tax-Free Bonds:
● Tax-Free Interest – The most significant benefit is the exemption from income tax on interest earned, enhancing the post-tax return.
● Low-Risk Investment – Tax-free bonds are considered very safe with government backing and high credit ratings.
● Stable Income – The fixed interest payments provide a predictable income stream, which is beneficial for financial planning.
● Long-Term Investment – The long tenure aligns well with the investment horizons of those seeking long-term stability.
Considerations and Risks:
● Interest Rate Risk – Tax-free bonds are subject to interest rate risk. If market interest rates rise, the value of existing bonds may decline.
● Liquidity Risk – While these bonds can be sold in the secondary market, liquidity varies. Bonds with lower trading volumes may be harder to sell without a discount.
● Capital Gains Tax – Selling tax-free bonds before maturity can attract capital gains tax, depending on the holding period.
Comparing Tax-Free Bonds to Other Investments:
Tax-free bonds offer a unique advantage over fixed-income investments like fixed deposits (FDs) and taxable bonds. While FDs and taxable bonds offer higher pre-tax returns, their post-tax returns can be significantly lower for investors in higher tax brackets. On the other hand, tax-free bonds provide a steady income stream without tax burden, making them more lucrative in the long run.
Conclusion:
Tax-free bonds in India are an excellent investment choice for those seeking stable, tax-efficient income with low risk. Their government backing and high credit ratings make them a secure option, especially for retirees and conservative investors. While they come with considerations such as interest rates and liquidity risks, their benefits often outweigh these concerns.
Investors should carefully evaluate their financial goals, risk tolerance, and liquidity needs before investing in tax-free bonds. By doing thorough research and considering the long-term benefits, investors can make informed decisions that align with their financial strategies and help secure their financial future.
Disclaimer:
CBD:
Qrius does not provide medical advice.
The Narcotic Drugs and Psychotropic Substances Act, 1985 (NDPS Act) outlaws the recreational use of cannabis products in India. CBD oil, manufactured under a license issued by the Drugs and Cosmetics Act, 1940, can be legally used in India for medicinal purposes only with a prescription, subject to specific conditions. Kindly refer to the legalities here.
The information on this website is for informational purposes only and is not a substitute for professional medical advice, diagnosis, or treatment. Always seek the advice of your physician or another qualified health provider with any questions regarding a medical condition or treatment. Never disregard professional medical advice or delay seeking it because of something you have read on this website.
Gambling:
As per the Public Gambling Act of 1867, all Indian states, except Goa, Daman, and Sikkim, prohibit gambling. Land-based casinos are legalized in Goa and Daman under the Goa, Daman and Diu Public Gambling Act 1976. In Sikkim, land-based casinos, online gambling, and e-gaming (games of chance) are legalized under the Sikkim Online Gaming (Regulation) Rules 2009. Only some Indian states have legalized online/regular lotteries, subject to state laws. Refer to the legalities here. Horse racing and betting on horse racing, including online betting, is permitted only in licensed premises in select states. Refer to the 1996 Supreme Court judgment for more information.
This article does not endorse or express the views of Qrius and/or its staff.
Stay updated with all the insights.
Navigate news, 1 email day.
Subscribe to Qrius
