The Tax Free bonds are issued under the Section 10(15)(iv)(h) of the Income Tax Act, 1961 . Certain entities , mainly in the PSU sector are allowed to raise money for their long term requirements , generally for infrastructure project financing with higher gestation periods. To make their offers competitive and attract investors, the government has allowed the investors the benefit of tax savings on interest income (coupon payment) received from these bonds.
· From the point of investment , these bonds provide the investors the opportunity to look at an alternate class of investments beyond the Fixed deposits, Bank or Corporate.
· The companies which issue these bonds are all in the PSU Sector and have a low risk profile with higher ratings.
· The investor with surplus funds can lock onto the rate for a longer period (5,10,15,20 years) unlike other fixed deposits available.
· Investors with surplus fund can plan a fixed cash flow for the future without the hassle of worrying about the Tax obligations.
· It can be used to maximize the return of investments with a lower risk.
· The bonds are in dematerialized form and trade-able. They can be sold later on the Exchanges. However , there is a chance of loss or profit on secondary market transactions depending upon the price in the market.
You must be aware that the interest income earned through fixed deposit is taxable, if the interest amount exceeds Rs 10,000, in any financial year. This income is added to your total income under header Income from other sources and then taxed as per the income slab. If one compares the return from the Tax savings bonds with a FD then we find that the effective returns are much higher than the guaranteed coupon for an investor from a tax planning angle after exhausting the limit of FD investment for which interest income is non taxable ( i.e. after getting interest income beyond Rs 10000). See the chart below for an illustration.
Let us consider a person who has already invested in FDs for which he is receiving more than Rs 10000 as interest income annually. He wants to invest in Fixed income instruments. A tax free bond of coupon 8.50% is his investment option . See how he maximizes his return.
Now we can understand that what is the difference between Fixed Deposit return and Tax Free Bond return.So now we are in a position to explain the advantage of Tax Free Bond.