Stay alert for tax-free bonds

     Print Edition: December 2012

With most long-term fixed deposit rates settling in the 8.5-8.75% range, investors looking for fixed-income instruments have an opportunity to invest in tax-free bonds that can give higher post-tax returns than bank fixed deposits (FDs).

By March 2013, 10 government-owned infrastructure companies would issue Rs 53,500-crore worth of tax-free bonds. As interest earned from these bonds would not be taxed, investors would earn a better post-tax return than from FDs.

The interest earned on bank FDs and other normal bonds are added to the income of the investor and taxed as per the income-tax slabs. Post-tax return from an FD that offers 8.5% annual interest would be 5.9% for an individual in the 30% tax bracket.

Tax-free bonds are rated long-tenure (usually 10-15 years) fixed-income securities offering annual interest at rates less than the yield of government securities of similar tenure. At present, 10-year government bonds are trading around 8.2%. Going by these rates, one can expect the interest rate to be 7.5-8%.

One can buy and sell these bonds on the stock exchanges. Though the interest earned on these bonds is tax-free, any capital gain from sale in the secondary market is taxable.

Short-term capital gains are taxed at the normal rate, while long-term capital gains are taxed at 10% without indexation and 20% with indexation. Indexation is adjusting the purchasing price with annual inflation.

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