Tax-saving bonds are one among the important tax-saving options available to individuals. Interest incomes generated by them are tax deductible and this is over and above the `1 lakh tax exemption investors can avail of under Section 80C of the I-T Act.
A disadvantage of tax-saving bonds is that the interest rates offered are not adjusted for inflation which, at current 10 per cent levels, can significantly erode the value of bond investments.
The bonds are for individuals with low risk appetite, who are looking to primarily preserve income and earn returns on the same as a secondary goal. Tax-saving bonds are issued by RBI and organisations belonging to both public and private sectors.
The Union Budget for 2010-11 introduced infrastructure bonds to help finance infrastructure projects which usually take 3-10 years to complete. Resident Indian individuals and HUFs can invest in the bonds and get a deduction of maximum `20,000 in computation of taxable income for the current financial year.
This would enhance participation of retail investors in infrastructure financing. Individuals investing in tax-free infrastructure bonds can achieve a tax-saving of `2,000-6,000 per annum depending on the applicable tax slab. The bonds have maturity period of 10 years with a five year lock-in period without a buy back option from the issuing company.
Here is a brief look at some of the options available currently:IDFC has issued (from 30 September) tax-saving infrastructure bonds of 10 year maturity and eight per cent rate to raise `3,400 crore. It has till March 2011to raise the entire amount. The bonds are rated LAAA by ICRA, indicating highest degree of safety. This is the first public issue of tax-saving bonds by an infrastructure company. Investors can expect a few more in the short-term future owing to growing spending on infrastructure development. RBI issues tax-free “RBI Relief Bonds,” which offer 8.5 per cent interest rate compounded every six months. The bonds are extremely safe and mature in five years.
A special feature is that these can be pledged as securities in a bank for borrowing credit. RBI Relief Bonds can be sold to another party in the secondary equity market and this provides liquidity to the investor.
The relatively small face value of `1,000, other types of bonds, provides additional liquidity as it simplifies the transferring process to a third party and provides flexibility to the investor in terms of choosing the fraction of the total bond investment to sell off. ICICI Bank, India’s largest private sector bank, issues tax-saving bonds ‘ICICI Safety Bonds’ which offer a reduction in tax liability upto `16,000 per annum under Section 88 of the I-T Act.
Investors have three options to choose from — three-year bonds offering nine per cent returns on two face values of `5,000 and `6,600, and 6.5 year bonds with face value of `9,000 offering a nine per cent return. The returns offered by these bonds are higher than that of government entities as the former, being issued by a private enterprise, have some amount of default risk associated with it. The finance ministry has approved public issue of tax-free, secured bonds of `1,000 face value by the Indian Railways Finance Corporation for raising `3,080 crore in the financial year ending March 31, 2011.
The bonds would yield interest rates in the range of 6-7.25per cent per annum, depending on the size and maturity of a tranche. IRFC bonds are a lucrative option for investors in the 30 per cent tax bracket.
The bonds are guaranteed by the government and therefore are as safe as bank deposits.
Return generated by the bonds are much higher than bank deposits. Returns of 6-7.25 per cent in taxable instruments are approximately equivalent to 9-11 per cent returns in taxable instruments for an individual in the 30 per cent tax bracket. Bank FDs are currently offering 7-7.75per cent depending on maturity.
Capital gains tax-saving bonds are not tax-saving bonds per se and are used to save capital gains tax only.
Long-term capital gains generated by assets like property and gold can be invested in Section 54EC tax-saving bonds having lock-in period of three years.The investor has to pay taxes only on the interest income generated by the bonds and not on the entire amount received as capital gains.
(The writer is the CEO of bankbazaar.com.)
Overview of tax-saving bonds
Here are some of the institutions that offer tax-saving bonds and the interest rate offered.
Instrument Rate offered Maturity
IDFC 8% 10 years
RBI Relief Bond 8.5% 5 years
ICICI Safety Bond 9% 3 years
ICICI Safety Bond 9% 6.5 years
IRFC 6-7.25% Variable