How And Why To Buy Tax Free Bonds In India?

There are very few instruments in India, where the interest earned is tax free in the hands of investors. One of them is the Public Provident Fund, while the other is the interest earned on the Employees Provident Fund. However, in the case of the EPF one has not to withdraw the amount for 5-year to avail tax free income. Another instrument that offers tax free interest income in India is the tax free bonds.

What are the tax free bonds?

There were many companies a few years ago that were allowed to offer interest income as tax free by the Government of India, through tax free bonds. Some of these companies that issued tax free bonds were for a period of 10, 20 and 25-years. The prominent among these were the REC, HUCDO, Indian Railways Finance Corporation, Power Finance Corporation etc. Interestingly, these are all government owned companies.

Why to buy tax free bonds?

As indicated earlier, if you buy tax free bonds, the interest earned on these bonds is tax free. All of these companies offer interest on the bonds once every year, until maturity. Let us say as an example you have the fixed deposit of State Bank of India. When you earn interest from this deposit, it is added to your total income and you are taxed accordingly. However, when you get interest from tax free bonds it is exempted.

Where to buy tax free bonds and what is the interest rates?

If you have a trading and demat account to buy shares, you can buy tax free bonds. For example, just as you would buy shares and hold in your demat account, so also you can buy bonds and hold in your demat account. These tax free bonds are listed on the BSE and NSE just like shares.

Now let us take an example and provide some more details. The NA series of Bonds of Indian Railways Finance Corporation offers an interest of 8.65% every year, which is tax free. The interest is payable in Feb every year and the bonds mature in 2029. While the interest is 8.65%, the bonds are priced at Rs 1,250, which means your yields drop.

Now let's take another example, the REC N5 series of bonds offer an interest rate of 8.01% payable every year in the month of Sept. The bonds expire in the month of Sept 2023. However, the bonds are priced at Rs 1341, which means the yields drop to 5.92%.

One has to evaluate their own taxable status and then go in for tax free bonds. If you are in the highest tax bracket and if you are getting even post tax yields of 5% it makes sense to buy tax free bonds.

However, it is advisable not to buy large amounts of tax free bonds as sometimes they are not to liquid. So, stick to smaller volumes, but, you can buy different series after examining the yields on them.

The author

Sunil Fernandes, the author of this article has spent 2 and half decades covering business and finance in India and abroad. Sunil has worked with frontline daily newspapers and investment magazines in India and abroad.