Infrastructure Bonds and Tax Free Bonds

by Gopal Gidwani on February 2, 2012 · 1 comment

in Financial Planning,Fixed Income Securities,Others,Taxation

Introduction
The year 2011 was not very good for the Indian equity markets. The market indices Nifty 50 and Sensex 30 ended with losses of around 25% and the losses in most individual stocks were even higher. The New Year has arrived and it is February and tax planning season has started. Like his annual ritual Kapil Sharma has started scouting for investment avenues for saving tax. This year Kapil is giving priority to safer and low risk investment products available in the market. Kapil Sharma is a 30 year old individual and till last year was not afraid of taking risks. But last year he had suffered substantial amount of losses on his investments, due to high market volatility, which has forced him to look for safer options.

Kapil Sharma is not alone. Due to high market volatility, this year many investors have started looking for low risk and safer investments. The good news is that this year, investors have some additional options available for investment to add on to their tax saving investments bouquet – Infrastructure Bonds and Tax Free Bonds. These not only help investors in saving on their taxes but also offer decent returns and have low risk compared to equities.

Infrastructure Bonds and Tax Free Bonds are sub-categories of products among the broader category of NCDs (Non-convertible debentures). Recently lot of Government owned entities, NBFCs and infrastructure companies have launched bond issues. Before we carry on with our discussion on these bonds further, let us first have a brief discussion about NCDs and different types of NCDs available in the market.

Non convertible debentures (NCDs)
Non convertible debentures are debt instruments that are issued by a company to raise capital for business purpose. There can be 2 kinds of debentures: Convertible and Non-convertible.

Convertible debentures can be converted into shares of the issuing company after a certain time period. Whereas non-convertible debentures always remain as fixed income debt instruments and cannot be converted into shares.

Non-convertible debentures can either be secured or unsecured. Secured NCDs are secured by assets of the company. Unsecured NCDs are not backed by any kind of assets. Hence in case of any eventuality such as bankruptcy, the company assets will be liquidated and for repayment, secured NCDs holders will be given preference over unsecured NCDs holders.

Different NCDs that are available in the market for subscription
There are three kinds of non-convertible debentures that are presently available in the market:

1. High yield non-convertible debentures: First in the category of NCDs that have been launched in the market in the recent past are high yield NCDs. These have been launched by banks and Non Banking Financial Corporations (NBFCs). Most recent example is of Muthoot Finance Ltd, an NBFC, which promised pre-tax yield between 13-13.14%.

Some of the other NBFCs which had launched their NCDs in the recent past are – Shriram City Union, India Infoline Investment Services Ltd, Mannapuram Gold, Tata Capital etc. SBI had also come up with retail bonds issue and it got a fabulous response from the target audience.

2. Infrastructure Bonds (Section 80CCF): These bonds can be issued by Non Banking Financial Corporations (NBFCs) that are classified as Infrastructure Finance Companies by RBI. These bonds are used to fund infrastructure projects and have a maturity period of 10-15 years. The lock-in period for these bonds is 5 years and they can be sold any time after that or retained till maturity of 10-15 years and redeemed on maturity date.

Infrastructure bonds have a minimum lock in period of 5 years and the interest payable is linked to 10 Year Government of India (G-Secs) Bonds. Hence the rate of interest can range between 8-10% for these bonds. Infrastructure bonds are listed on the BSE and NSE and can be traded in demat form after the lock-in period of 5 years.

An individual who invests in these infrastructure bonds can claim deduction of upto Rs. 20,000 from taxable income, under Section 80CCF of the Income Tax Act. This deduction is over and above the existing combined deduction limit of Rs. 1,00,000 under Section 80C, 80CCC and 80CCD of the Income Tax Act. In other words, if an individual invests Rs. 20,000 in infrastructure bonds, this amount can be deducted from his total taxable income while calculating income tax. However interest income earned on these bonds will be taxable depending on the taxable income of the individual and the tax rates prevailing at that time.

Infrastructure bonds have become quite popular as one of the tax planning tools in recent times. Some of the recent infrastructure bond issues launched in the market were – L&T Infra, IDFC, IFCI, PFC, REC, PFS etc.  Below is a snapshot of some of the infrastructure bonds issues (still open) that can be considered for investment.

Infrastructure bond issued by Rural Electrification Corporation (REC)PTC India Financial Services (PFS) Infrastructure Development Finance Corporation(IDFC)L&T Infrastructure Finance Company Limited
Issue close date10th Feb 201229th Feb 201225th Feb 201211th Feb 2012
Tenure10 and 15 years10 and 15 years10 years10 years
Face valueRs 5000Rs 5000Rs 5000Rs 1000
Interest rate8.95% for 10 years
9.15% for 15 years
8.93% for 10 years
9.15% for 15 years
8.7%8.7%
Buyback option For 10 year bonds – at the end of 5 years and 1 day.
For 15 year bonds – end of 7 years and 1 day
Buyback option is available every year after lock in period.
Lock in period for 10 years bond is 5 years and for 15 years bonds it is 7 years
At the end of 5 years and 1 dayAt the end of 5 years
Type of bondsUnsecured, redeemable and non convertible bondsSecured, redeemable and non convertible bondsSecured, redeemable and non convertible bondsSecured, redeemable and non convertible bonds
BSE/NSE listingListing on BSE and NSEListing on BSE and NSEListing on BSE and NSEListing on BSE
Credit RatingAAA stable  by CRISIL
LAAA by ICRA
CARE AAA by CARE
AAA by  Fitch
A+ by CARE
A+ by ICRA
AA by Bricwork
AAA by ICRA
AAA by Fitch
AA+ by CARE
AA+ ICRA
Minimum application1 bond (Rs 5000)1 bond (Rs 5000)2 bondsRs 5000, i.e. 5 bonds of Rs 1000
Bond issuance Both physical and demat formBoth physical and demat formBoth physical and demat formBoth physical and demat form
RegistrarBeetal Financial & Computer Services Ltd.Karvy Computershare Private LimitedKarvy Computershare Private LimitedSharepro Services (India) Private Limited

Analysis
Interest rates offered by REC and PFS are higher at 9.15% for 15 years tenure. But credit rating for PFS and L&T Infra is low as compared to REC and IDFC.

3. Tax Free Bonds: Recently HUDCO, IRFC and NHAI have come out with tax-free bonds issues for raising long term funds to be used for infrastructure development of the country.

In these tax free bonds, investor does not receive any tax deduction benefit on principal amount being invested. Instead, in these bonds the interest earned is tax free!!! Also there is no TDS applicable on these bonds. However capital gains on these bonds are taxable like normal corporate bonds.

Difference between REC, PFS, IDFC, L&T infra Bonds and NHAI, HUDCO, IRFC Bonds
The bonds offered by REC, PFS, IDFC, L&T Infra offer deduction of Rs. 20,000 from taxable income under Section 80CCF of the Income Tax Act. Whereas Section 80CCF deduction is not available in bonds offered by NHAI, HUDCO and IRFC.

But the interest earned from REC, PFS, IDFC, L&T Infra is taxable. Whereas the interest earned from HUDCO, NHAI and IRFC bonds is tax free.

The bonds offered by REC, PFS, IDFC, L&T infra have a lock-in period of minimum 5 years and the bonds offered by NHAI, HUDCO and IRFC have no lock-in period.

Tenure of tax free bonds being offered by HUDCO, NHAI and IRFC is 10-15 years but these do not have any lock-in period. Interest rates offered depend on tenure of the bond and category of investor.

These bonds will be listed on the BSE and NSE and investor will have the option of selling the bonds before maturity. Though these bonds are available in both physical and demat form, but they can be traded only in demat form in secondary market. The capital gains on the sale of bonds is taxable like normal corporate bonds

At present bond issues from Indian Railways Finance Corporation (IRFC) and Housing and Urban Development Corporation (HUDCO) are open for subscription. Here is a snapshot of both the bond issues.

Infrastructure bond issued byIndian Railways Finance Corporation (IRFC) LtdHousing and Urban Development Corporation (HUDCO) Ltd
About the companyIRFC is a dedicated financing arm of Ministry of Railways. Its prime responsibility is to raise funds from the market to part finance the plan outlay of Indian Railways.HUDCO is a fully owned enterprise of Government of India and is responsible for undertaking  housing and urban infrastructure development in  the country.
Size of the issueRs. 3000 crore with option to retain over-subscription upto specified limitRs 2000 crore with option to retain over-subscription upto specified limit
Series offeredSeries I
Series II
Series I
Series II
Issue close dateFebruary 10, 2012February 6, 2012
TenureSeries I – 10 years
Series II – 15 years
Series I – 10 years
Series II – 15 years
Face valueRs 1000Rs 1000
Interest rate for retail investorsSeries I – 8.15% p.a.
Series II – 8.30% p.a.
Series I – 8.22% p.a.
Series II – 8.35% p.a.
Interest rate for other investorsSeries I – 8.00% p.a.
Series II – 8.10% p.a.
Series I – 8.10% p.a.
Series II – 8.20% p.a.
BSE and NSE listing Listing on BSE and NSEListing on BSE and NSE
Type of bondsSecured, redeemable and non-convertible bondsSecured, redeemable and non-convertible bonds
Credit RatingAAA by CRISIL
AAA by ICRA
AAA by CARE
AA+ by CARE and Fitch
Minimum application10 bonds and in multiples of 5 bonds thereafter10 bonds and in multiples of 1 bond thereafter
Bond issuance Both physical and demat formBoth physical and demat form
RegistrarKarvy Computershare Private LimitedKarvy Computershare Private Limited

Analysis:

  • Interest rate offered by HUDCO for both 10 and 15 year series is little higher than that of IRFC. However in terms of credit rating, IRFC is rated higher than HUDCO by the rating agencies. However as both of them are government backed entities, hence can be considered as low risk!
  • Both the issues have a step down feature i.e. retail investors will be able to enjoy slightly higher interest rates that other category of investors. Retail investors who buy the bonds from the secondary market will be offered lower interest rate as applicable to non-retail category investors.
  • Investors are provided with liquidity options as these bonds can be traded in secondary market, and one can exit before the maturity or redemption date of these bonds.

Conclusion
Tax free bonds are a good choice for low risk and moderate risk investors. As against infrastructure bonds, the interest earned on IRFC and HUDCO Bonds is tax free and will not be taken as part of total income for calculation of income tax. These bonds don’t have any lock-in period. As these bonds will be listed on the stock exchange, hence they offer liquidity to investors as well. Tax free bonds can be a good choice for investors who are in higher end of tax group and are looking for investing an amount more than Rs 1,20,000 over and above the deduction offered under Section 80C and Section 80CCF.

If looked from tax saving perspective, investment in tax saving (80CCF)infrastructure bonds can be a good choice for such investors who are looking for additional tax saving above Rs 1,00,000 under Section 80C of the Income Tax Act.

For any comments please comment in the section below or email us at gopal_gidwani@yahoo.com

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