About Tax Free Bonds

What's the Big Deal With Tax Free Bonds?

With one year fixed deposit interest rates fetching close to 8.5-9% p.a., investors with a view on long term debt investments, could look at the upcoming tax free bonds issue. Therefore, it becomes important that investors should know all about Tax Free Bonds, so they can make the right investment decisions.

What Are Tax Free Bonds?

Tax Free Bonds are issued by select central government PSUs and as the name suggests they are tax free instruments. Interest from these bonds does not form a part of the total taxable income, and hence these bonds become lucrative investment options. Unlike other fixed income instruments like fixed deposits (FDs), where the interest you earn comes under your taxable income, the interest earned from tax free bonds is simply - tax free! Needless to say, these Tax free bonds become best suited investment options for investors falling in the highest tax bracket.

Lets consider Ram and Shyam who both earn Rs. 15 lakhs per year. Ram invests Rs. 1 lakh in a fixed deposit fetching him 9% p.a for 1 year. Shyam on the other hand invests Rs. 1 lakh in a tax free bond at 8.26% p.a. for 10 years. They both fall in the highest tax bracket of 30%. Lets see how their taxable income will differ:

	Ram	Shyam
Income (Rs.)	15,00,000	15,00,000
Interest earned from investment (Rs.)	9,000 (9% of Rs. 1 lakh)	8,260 (8.26% of 1 lakh)
Taxable income	15,09,000	15,00,000

Why should I invest in Tax Free Bonds?

• The biggest reason you should invest in a Tax Free Bond is Tax free interest:
  For a head to head comparison, a Tax Free Bond (TFB) scores over a bank FD since the interest is tax free in the hands of investors. Whilst in an FD, tax on the interest earned is deducted at the source itself. The interest earned on Tax Free Bonds is free of tax. But remember, the amount you invest in these bonds will not get any deduction under any section of the IT act.

  Lets consider how Ram and Shyam’s tax implication will differ due to their investments:

  	Ram (invested in FD)	Shyam (invested in TFB)
  Income (Rs.)	15,00,000	15,00,000
  Investment (Rs.) [A]	1,00,000	1,00,000
  Interest earned from investment (Rs.) [B]	9,000 (9% of Rs. 1 lakh)	8,260 (8.26% of 1 lakh)
  Tax on interest earned at 30% (Rs.) [C]	2,700 (30% of 9,000)	-
  Post tax return (Rs.) [D=B-C]	6,300	8,260
  Post Tax return (%) [D/A]	6.3%	8.26%

  
  Hence as we can see from the example above, the post tax return of Shyam (who invested in tax free bonds) is higher than Ram (who invested in a fixed deposit).
• Of course, beyond the savings on your taxes, these bonds also give you great safety:
  They are issued by state run companies, hence are quasi-government bonds and are safe to invest. Further most of them are rated AAA by leading rating agencies. AAA is the highest level of safety.
• Plus, they have a good possibility of lucrative returns with a high rate of interest:
  The interest rates offered by TFB are linked to the average yield of government securities of similar maturity in the previous days. The rates are expected to be higher this time around as the 10 year benchmark yield recently crossed 9%, an all time high. Therefore there arises an opportunity to lock in higher interest rates for longer duration like 20 years.
• Tax Free Bonds give you great flexibility with high liquidity:
  Since the bond is listed on the stock exchanges, trading on the same is allowed at the stock exchanges.
• What's more, if you are an individual retail investor, you also get a retail advantage:
  While 70% of the issue is reserved for public issuance, 40% of the issue is reserved for retail investors; hence they have a good chance of getting allotment. And with equity and debt markets facing tough times, this could be a good option for investors to lock in higher rates of interest.

Let's see a comparison of the various debt products available in the market

	Tax Free Bond	Fixed Deposit	Debt Funds
Capital Protection
Liquidity
Pre tax yield (~12%)
Market linked returns

And lastly, how can I go about investing in Tax Free Bonds?

• Invest in TFB by submitting a physical form furnishing the details as requested.
• Investors can apply for Tax Free Bonds in the Primary market by simply logging onto www.edelweiss.in and can enjoy the ease of investing.
• Also, since the Tax Free Bonds are listed on the BSE or NSE, investors can buy Tax Free Bonds in the secondary market as well.

So, if you are an investor with a long term horizon and are looking out to make stable returns on your surplus fund, logon to www.edelweiss.in and apply for a Tax Free Bond now!