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Monday, January 30, 2012

Infrastructure Bonds: Investment makes sense !!!

Lots of us have being hearing a lot on Infrastructure bonds and the tax exemption on it, many companies are coming out with their issues. Also its is almost that time of the year when you need to submit proofs of investments made by you to make sure that the tax deducted from your salary takes into account such investments. Infrastructure bonds are one of the investments options to save tax. Investments of upto Rs. 20,000 in such bonds qualifies for tax deductions.
Section 80CCF was introduced in the Income Tax Act, 1961 in the budget of February 2010. As per this section investments made in notified infrastructure bonds are exempt from tax up to maximum of Rs 20,000 per year. Section 80CCF allows individuals to invest Rs. 20,000 in infrastructure bonds, and reduce this amount from taxable income. This exemption is in addition to the Rs. 1,00,000 deduction under section 80C (Investment in instruments like ELSS Mutual Funds, Life Insurance, Provident Fund etc). But the interest income from infrastructure bond is taxable. The interest will be added to investor’s taxable income. This means even though the investment in these bonds is exempt from tax (maximum Rs 20,000) its interest income is not. This means investment under section 80CCF is advisable only after the investor has completely exhausted Rs One Lakh investment under section 80C.
Investment in infrastructure bonds makes sense for all tax payers given the good post tax returns. But investments are capped up to Rs.20,000 per annum for qualifying deductions, Beyond that, there are several other debt options that provides better  returns. The only decision, that remains for the tax payer is Should you invest now or wait for better yielding infrastructure bonds in the next year? This question is natural with given that the last year’s experience where those who waited till the last minute got better interest rates.
Company’s offers interest rates on the bonds based on the returns on comparable government securities for the prescribed period before the issue of the bonds. The government securities market is very volatile and is expected to remain so. Hence, it is difficult to predict whether future issues of such bonds are likely to carry the same or higher (or even lower) interest rates. Given the facts that this investment are capped at Rs. 20,000, it is unlikely to make a major difference (either way) to an investor and So, it is always better to get a highly - rated bond when available.
Now one will ask that Should you opt for buyback option after 5 years or to wait till 5 year lock-in period and then decide whether to continue with the bond for a further period or opt for the buyback option?
The answer would be that Your bonds will be priced at a premium, if you continue with the bond and if the interest rates for five year bond are ruling lower than 9 % at the end of five years, you can however, suffer a capital loss if you continue with the bonds at the end of five years and if the interest rates for such bonds are higher than 9 % at that time.
Given the low value of the investment vies – se – versa a high taxpayers overall investment portfolio, it is most unlikely that you will do a proper review before taking this decision, Hence, Choose the buyback option while applying for the bonds so that your returns are locked in. If you are able to take a proper review at the end of 5 years, you are allowed to change your selection but at least your criteria in taking a decision will not cost you adversely.
While making decision which bond to buy one should take into consideration the group issuing such bond; the kind of rating given to these group or its bonds. I would go for the bond  with higher rating at AAA as against AA+ issue & will go for public sector as against private companies for higher safety.
If a bond offers 9 % per annum – the post tax returns works out to 10.85 % (for those in the 10.30 % tax bracket), 13 % (20.60 % tax bracket), and 15.56 % (tax rate 30.90 % ). The returns are definitely good. This, of course assumes that you will use the buyback facility provided by the company at the end of five years and that the tax rate will remain constant throughout the 5 year period.
Currently IFCI TAX FREE BOND Series IV issue is open till 8th February 2012; REC Infrastructure Bonds; SREI Infrastructure Bonds; PFS Infrastructure Bonds are on the block. Other than these companies Tax Free Bonds are also being issued by NHAI (National Highways Authority of India), IRFC (Indian Railway Finance Corporation), HUDCO (Housing & Urban Development Corporation) as well as PFC (Power Finance Corporation). The Central Board for Direct Taxes has allowed these companies to rise up to Rs. 30,000 Crores by issuing Tax Free Bonds for the financial year 2011-2012.
Since the above mentioned Tax Free Bonds by NHAI, IRFC, HUDCO, PFC cannot be directly classified as Tax Free Infrastructure Bonds we limit our discussion on them here.
However here is a basic comparison of all Open Tax Free Infrastructure Bonds Offerings (IFCI, REC, SREI, PFS):

Particulars IFCI REC SREI PFS
Issue Closes 8th Feb 2012 10th Feb 2012 31st Jan 2012 29th Feb 2012
Coupon Rate 9.09%/9.16% 8.95%/9.15% 8.90%/9.15% 8.93%/9.15%
Tenure 10yrs/15yrs 10yrs/15yrs 10yrs/15yrs 10yrs/15yrs
Buyback option at the end of 5/7 yr for 10yr bonds &5/10 yr for 15yr Bonds 5/7 yr for 10yr bonds &5/10 yr for 15yr Bonds 5/7 yr for 10yr bonds &5/10 yr for 15yr Bonds Every Year(After 5th)-10yr Bonds; Every yr (After 7th)- 15 yr Bonds
Rating 'AA-'-Brickwork;'A+'-CARE;'A'-ICRA NOT KNOWN 'AA'-CARE NOT KNOWN
Face Value Rs.5,000 Rs.5,000 Rs.5,000 Rs.5,000
Mini.Application 1 Bond 1 Bond 1 Bond 1 Bond

You can contact your broker for the application forms or you can also visit the respective companies websites for the online application . I have tried to bring a broader picture on Infra bonds 
Visit Companies Website links below for Infra Bonds - 
PFS
IDFC


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*Disclosure : The post just expresses the views of the author. Investment in Infra bonds depends on certain factors like risk profile,income, age etc. Do consult your financial planner before making investing decisions.

5 comments :

  1. Good detailed post. You have clearly drafted the interest rate risks associated with bonds, Nice.

    ReplyDelete
  2. Hi Srinath
    Thanks for commenting on post.
    I just try to make my investor friends understand markets better - whether it is Equities or debt.
    Thanks once again do visit again.

    ReplyDelete
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