Tax Free Bonds Are Back

Tax free bonds are once again on their way to the markets. The government has approved the issue tax-free bonds, which comes as a silver lining for retail investors. Of late the dismal equity and fixed income markets have left limited room for small retail investors to park their surplus funds. These bonds seriously compete with other instruments like fixed deposits and other instruments in the debt segment. Public undertakings like IIFC, IRFC, PFC, NHAI, HUDCO, REC, NTPC, NHPC, Indian Renewable Energy Development Agency, Airports Authority of India and Cochin Shipyard will be raising funds through this route. On an aggregate basis these companies are likely to raise around Rs 48000 crore.

With 70% of these bonds reserved for public issuance retail investors can be sure of getting their hands on at least a part of these. Of the above, 40% will be reserved for retail investors. What is even better is, risk-averse investor can earn decent returns over a longer time horizon while simultaneously enjoying tax benefits. Here is a quick take on how will these bonds will score over other instruments like bank fixed deposits and fixed maturity plans.

A five-year fixed deposit with banks come with a tax exemption under Section 80C and provides a return of 8-9% per annum. However, the interest income earned on five-year FDs is taxable. In tax-free bonds, the interest income is tax-free but any capital gains on selling the bonds are taxed. Fixed maturity plans (FMPs) of mutual funds, which come with a benefit of double inflation indexation, benefit are currently offering around 10.3-10.4%, while a three-year FMP offers around 9.8%.

These bonds are better suited for investors in the higher-tax bracket, as they yield around 10.5% pre-tax returns. For those in the 10% tax bracket, corporate fixed deposits with high credit ratings are better options since the return from the tax-free bonds would be around 8.5 per cent, while corporate FDs would give around 10-10.5 per cent though they are riskier.