Tax Free Bonds: An Overview

Income Tax
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Don’t you look for investments with high returns? You do! I do! Everyone does!

Let’s understand one such investment: Tax-free bonds. These are among the most popular instruments due to the benefit of no tax on the interest earned (returns).

So, what are tax-free bonds?

These are securities that offer regular or fixed interest payments in return for borrowed money. The interest earned is completely tax-free u/s 10. Tax-free bonds come with a long-term maturity period of 10, 15, and 20 years.

Who provides/issues these bonds?

Government entities like NHAI, REC, PFC, etc. issue tax-free bonds to raise money for various projects like infrastructure and housing.

How are these bonds issued?

One can buy these bonds in the Demat form or in the physical format when the subscription window opens for investors. But remember that these bonds are available for a limited time. Once the issue is over, these bonds are listed on the BSE & NSE and hence can be traded in the secondary markets, just like normal bonds.

What are the features of these bonds?

  1. Tax-Free: The interest earned is completely tax-exempt.
  2. Safe and Steady Income: Since these are government-backed instruments and the rate of interest is predetermined, you know exactly how much income you will receive and the chances of default on payment are quite low.
  3. Liquidity: Tax-free bonds cannot be liquidated as quickly as other asset classes. But since tax-free bonds are listed on BSE and NSE, one can buy tax-free bonds from stock exchanges.

Conclusion:

Thus, tax-free bonds are ideal for people with a risk appetite, high net-worth individuals looking for a steady source of annual income, and those who can afford to lock in their capital for longer tenures.

Though the interest received from these bonds is not taxable, any profits derived by selling these bonds in the secondary market are liable to taxes under the head Income from Capital Gains.

Have questions? Shoot’em here!

2 Likes
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Hi

Can these be bought only in the secondary markets?

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Hi @gdshan

These bonds can be bought when the entities such as NHAI, PFC, etc, open the window for the subscription of these bonds.
They can also be bought from the secondary markets.

4

Hi

Thanks for clarifying. When was the last time such tax free bonds were opened for subscription? Is there any source available to check for its subscription?

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Such tax-free bonds were last issued by NHAI and REC in 2015-16.

Since these bonds are issued by government-backed entities, you can regularly check their websites for the latest updates.
However, they are easily traded in the secondary market as well as they are listed in the recognized Indian stock exchanges. So you can buy them from any reputed stockbroker, bank, and others.

Hope this helps.

6

Any guidance to understand how to determine right price for such bonds in secondary market, depending on the original face value, coupon rate, number of years left etc.?

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Hi @irha

It is advisable to contact an investment/financial advisor for the same.
We will be able to help you better with your tax-related queries.

8

Hi @Shrutika_Shah

Is the interest earned on these bonds tax free even if its purchased in the secondary market notwithstanding if its not held until maturity? What is the tax implication on interest thus earned during a particular year and the same is sold during the same FY? Do we have to report such incomes in the ITR? If so, under which head?

1 Like
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Hi @gdshan

Yes, the interest earned on these bonds is tax-free even if it’s purchased in the secondary market. But these bonds cannot be redeemed/ withdrawn before maturity, but can only be traded on the stock exchange.

Upon redemption/ selling the profit you make is taxable under Section 112. Hence, the capital gains you get after selling the bond before one year are taxable as per your income tax slab. The interest earned is completely tax-free.

Yes, the income upon selling/redemption should be reported under “Income from Capital Gains” and the interest income should be reported under “Income from Other Sources > Exempt income.”

Hope this helps.

1 Like
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Hi @Muskan_Balar

In case of tax free bonds, the concept of accrued interest does not arise for the purpose of tax. Hence, should we treat the premium paid to purchase those in the secondary market as capital loss if held for more than a year and sold and offset it against any other LTCG and carry forward the residual for the next 8 years?

1 Like
11

Hi

Please clarify on the above query.

12

Hi @gdshan

Yes, the premium paid to purchase tax-free bonds can be considered a capital loss and the sale of these tax-free bonds in the secondary market can be set off against LTCG and the remaining can be carried forward.

Hope it helps

13

Hi @Muskan_Balar

Thanks a lot for clarifying. This setting off of loss against LTCG is available only if its sold in the secondary market? Means this set off is not available if the bonds/debentures are retired on its maturity?

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Hi @Muskan_Balar

Request your help on the above query.

15

Hi @gdshan,

Tax-free bonds are redeemed automatically, upon maturity and income arising from redemption is treated as capital gains. These gains can be categorized as long-term or short-term based on the holding period of the bonds.

So, yes If you have incurred long-term capital losses (LTCA) from the sale of other capital assets, you can set off these losses against the long-term capital gains (LTCG) from the redemption of tax-free bonds.

16

Hello, if we buy these tax-free bonds from secondary market, and then after 1 yr sold it in the same secondary market then capital gains arising will come under LTCG and the interest income got will be in IFOS exempt income. Is that correct?

17

Hey @delta,

Yes, in case of tax-free bonds, the LTCG will be taxed at 10% if sold after 12 months of holding. The interest received from these will be exempted.