TAX FREE BONDS

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Introduction:

If you are looking for a haven to park your funds in, here’s good news for you: Invest in tax free bonds and earn interest on your funds every year. There’s more good news; the interest earned on your bond is entirely tax-free.
The security of tax free bonds in India is issued by a company, financial institution or the government. These bonds are, therefore a safe investment option.
You can sell the bonds before maturity, too, on market price as they are listed on the Bombay and National Stock Exchanges.

What are the common types of tax-free bonds?

Tax-free bonds are pretty famous because they are, well, tax-free. These bonds are excellent choices for investors with low-risk appetites. Issued by government enterprises, these are the safest forms of investment.

There are mainly two types - tax-free and tax-saving. Here are the differences between the two types.

Tax-free Bonds Tax-saving Bonds
The interest income on tax-free bonds is tax exempted These help in tax saving by exempting initial investment from taxation
These bonds fall under Section 10 of the Income Tax Act Tax exemption received under Section 80CCF of the Income Tax Act
Offers higher interest payment than tax-saving bonds Lower interest payouts than tax-free bonds
One can invest up to the maximum limit of Rs 5 lakh Tax-exemption is available for an investment of Rs 20,000 per financial year
These bonds are available for 10, 15, and 20 years of maturity These bonds often carry a buyback clause allowing investors can redeem after 5 or 7 years

How to invest in tax-free bonds

Investors can buy these bonds when the government opens a subscription. However, these bonds are available only for a short time. You'd have to complete KYC and submit PAN details for receiving the bonds through an online or offline process.  These bonds are also available for trading post-issuance in the secondary market and traded like equities through trading accounts. 

How to redeem tax-free bonds

Investors can follow the simple redeeming process at maturity. Often these bonds have a tenure of 10-20 years and are not available for redemption before maturity. But one can trade these in the secondary market like stocks in the exchange. However, any capital gain from selling the bonds will attract capital gain tax under section 112. Selling these bonds before one year is taxable per the investor's income tax slab while selling after twelve months will attract long-term capital gain tax at the rate of 10 percent with no benefit of indexation.

Features of tax free bonds

These bonds have unique characteristics.

  1. Interest: The interest on these bonds is earned annually, and the Central government determines it. All interest earned is exempt from taxation.
  2. Tenure: Tax free government bonds usually come as long-term investment tools. You can invest in these bonds for up to 10, 15 or 20 years, depending on your needs.
  3. Liquidity: You can trade these bonds at any time as per the ongoing market rate. However, any profit from the sale of these bonds will be taxed under the IT Act.
  4. Form: You can hold these bonds in physical or dematerialised bonds. So you may choose to purchase using your demat account or purchase directly.

Benefits of tax free government bonds

The advantages of tax-free go beyond the fact that these bonds give you tax-exempt interest. Here’s why you should invest in tax free government bonds:

  1. Assured income: The interest you earn on these bonds is assured every year. You stand to earn tax-free income every year, apart from the principal that will be returned to you on maturity. Only Indian nationals and Hindu Unified Family are allowed to purchase these bonds.
  2. Safety: These bonds are backed by the government of India, which means the likelihood of default is low. Even if a company you bought bonds from goes bankrupt, its assets will be liquidated. As bondholders, you will get your investments back.
  3. Easy trade: The tax free bonds are listed on the stock market. So you can sell your bonds on the market price when the prices appreciate. You stand to benefit in any market appreciation.
  4. Higher profit for higher tax bracket: These bonds are an ideal investment option for high net worth individuals. So if you fall in the 30 percent or above tax bracket, you stand to gain more. Additionally there is no upper limit to investment in these bonds.

Conclusion (CTA):

Tax free bonds are a good option for anyone looking for a fixed tax free income from investments. If you are looking at fixed deposits and corporate bonds as an investment option, you should also consider tax free government bonds as an option. It is a safe option to fall back to without having to worry about liquidity.

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