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Investors in higher tax bracket find solace in tax-free bonds post Budget

These bonds are available in the secondary market as the govt has not issued after 2016.

, ET Bureau|
Last Updated: Feb 14, 2020, 07.55 AM IST
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With the government’s decision to make dividend taxable at the hands of investors in the recent budget set to increase their tax outgo, the list of instruments that help reduce taxes are shrinking.
Tax-free bonds of stateowned companies are gaining popularity with rich investors, who are looking for tax-efficient instruments to lock-in their money for the long-term.

With the government’s decision to make dividend taxable at the hands of investors in the recent budget set to increase their tax outgo, the list of instruments that help reduce taxes are shrinking.

“Tax-free bonds are the only instruments which are truly tax free and will carry that status till maturity as it was approved by parliament, " said Vikram Dalal, managing director, Synergee Capital. “There is interest amongst investors in these bonds especially after the budget, when dividend from preference shares started getting taxed, as per tax slab.”

Tax-free interest income and higher rates than fixed deposits of top lenders like State Bank of India are attracting rich investors to tax-free bonds. Such instruments of NHAI, PFC, REC, IIFCL and Hudco are ‘AAA’ rated and give a tax-free yield of 5.55-5.75 per cent, which on a pre-tax basis is 220-378 bps higher than fixed deposits of nationalised banks.

Bond snip 3

These bonds are available in the secondary market as the government has not issued after 2016. Debt dealers also sell them in lots of Rs 10 lakh each. Wealth managers point out that tax-free bonds are being accumulated by investors who typically pay income tax of more than 30 per cent, as the post-tax returns are far superior to fixed deposits.

“Ability to earn 200-300 bps higher than bank deposits, no put or call option and the AAA rating attract investors to these bonds,” says Dalal of Synergee Capital.

A deposit with SBI offers a maximum of 6 per cent for an individual earning above Rs 5 crore, who pays a tax at the rate of 42.7 per cent. In comparison, the pre-tax yield in a tax-free bond is 9.78 per cent. In the case of a person earning Rs 1-2 crore and paying a tax of 35.88 per cent, the pre-tax yield on a taxfree bond is 8.73 per cent.

“Investors buy these typically for longer tenure with the residual maturity being anywhere between 4 and 14 years, the investor can lock in the interest rate for his time horizon without worrying about reinvestment risk or tax changes,” said Deepak Jasani, head (retail research) at HDFC Securities. With no further issuances through primary markets, tax-free bonds are liquid on the stock exchange.
Click here for all the information and analysis you need for tax-saving this financial year

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