Monday, April 15News That Matters

Tax Free Bonds – Should you invest in these?


Tax free bonds are flavour of the market since 2012 with many Government & PSU companies raising thousands of crores from market via these Bonds.
There Bonds are offering good returns for long duration as well as tax free income.  In 2012-2013, Around 10 government owned companies raised Rs 50000 crores via tax-free bonds.

Positive Points

Safe & Secure – All tax-free bonds are issued only by government-owned companies. So they are unlikely to default. These are normally rated AA or higher.

Tax FREE Interest –  Interest received on these bonds are fully exempt from income tax.
( as per Section 10 (15) (iv) (h) of Income Tax Act, 1961)

No TDS –  Since the interest income on these Bonds is exempt from tax, no Tax Deduction at Source (TDS) is required.

No Wealth Tax –  Wealth Tax is not levied on investment in bonds under section 2(ea) of the Wealth-tax Act, 1957

Higher Pre Tax Yield compared to Bank FD – Pre-Tax yield on such Bonds are higher than normal Bank FD (for those who are in 30% tax slab). So if both FD & tax free bonds are offering 9% interest, these bonds will give better pre-tax yield.

Posiibility of Capital Gains – As these bonds are listed, you can sell them on stock exchanges like you sell the shares. If the interest rates go down in future (which is highly likely), the bonds prices will go up & you will be able to get extra profit,

  Pre tax yield Post Tax yield
( assuming 30% tax slab)
Bank FD 9% 6.30%
Tax Free Bonds 12.86% 9%
Assuming both offering 9% interest

Points to consider

Long Duration – These bonds are gor long term maturity  – 10, 15 & 20 years

Low Liquidity – Though these bonds will be listed on stock exchange & you can sell these early, but they are not very liquid & donot trade in huge volumes. So you might not get better price at pre maturity exit.

Re-investment Risk – Interest is paid annually by Tax free bonds and you have to take care of investing them back. While it case of Bank FD, the interest is compounded at the same FD rate.
If you donot need the money annually, then you can open an RD or Debt mutual fudn SIP which can be funded by the Interest received from Tax free Bonds.

How to Invest

1) You can download the Form from the Company’s website & submit the physical form & cheques to Point of Contact / Investors Centres

2) You can also apply via Online Share Trading Portals like ICICIDirect, ShareKhan, HDFCSec, Reliance Money etc

Taxation on Capital Gain

While Interest on such Bonds are Tax free, if you sell these bonds before maturity in secondary market, you need to pay Capital Gains tax.

Long Term Capital Gain  :    If you sell the bond after 12 months of purchases, it will be treated as Long Term Capital Gains

Long Term Capital Gains for listed securities are taxed   (Under Section 112 of the Income Tax Act,)
@  20% of with Indexation  or
@ 10% without Indexation

However as per third proviso to Section 48 of Income Tax Act, 1961 benefits of indexation of cost of acquisition under second proviso of Section 48 of Income Tax Act, 1961 is not available in case of bonds and debenture, except capital indexed bonds.

Thus, long term capital gain tax can be considered at a rate of 10% on listed bonds without indexation.

Short Term Capital Gain   –   If you sell the bond within 12 months of purchases, it will be treated as Short Term Capital Gains and will be taxed at normal rates of your tax slab.. So if you are in 30% tax slab, this capital gain will be taxed at 30%.


If you are in high tax slab, you can consider investing in these bonds as they offer good pre tax yield.

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