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To claim tax benefit we all look for some instrument which will save tax and also offer relatively higher returns after the tenure. Some popular tax saving-cum-investment instruments are PPF and ELSS. But some also look for tax free bonds and tax saving bonds. Experts say most people get confused between these two options. There are several differences between tax free bonds and tax savings bonds. While one lets investor enjoy tax benefits on the principal amount, the other offers the liberty to have tax holiday on the interest accrued.

Similarly, while one comes with a lock-in period of 5 years, the other has no such lock-in period.

Tax savings bonds

Tax-savings bonds offer tax benefits to the investor, therefore helping them save a certain portion of the overall tax to be paid. Investors can earn a certain interest on these bonds if opted for, along with the special provision in the Income-Tax Act.

A special provision for tax saving bonds is offered under Section 80CCF. Under this provision, investors get the benefit of tax deductions up to Rs 20,000. But the interest earned through the bond is taxable.

Deduction offered under section 80CCF is over and above tax deduction u/s 80C of IT Act. A tax saving bond comes with a minimum lock-in period of 5 years and is ideal for mid to long term investment.

Returns from these tax saving bonds are low when compared to other investment options. Additionally, investors looking for long-term returns could also opt for these tax saving bonds, as they are not suitable for individuals looking for short term returns.

Tax-free bonds

According to the Income Tax Act, 1961, tax free bonds do not attract any tax on the earned interest, unlike tax- saving bonds.

Investors, however, do not get any tax benefits on the amount invested or the principal amount, unlike tax savings bonds. These bonds are not eligible for deductions under section 80C of the I-T Act.

These tax-free bonds offer a slightly higher interest rate (up to 1.5 percentage point) as compared to tax saving bonds. But these bonds are generally for long-term investment, like tenure up to 20 years or more.

An investor can invest a maximum up to Rs 5 lakh in tax free bonds in a fiscal year. The interest earned from these tax free bonds is free from tax, but selling these tax free bonds in the secondary market is fully taxable.

How can you invest?

Tax-free bonds have trading options that allow bond trading through demat accounts or in physical form. The subscription period for the investment is open only for a specified window.

When the government issues bonds to the public, the investor can subscribe by applying online or offline.

On the other hand, you can buy tax savings bonds from all public sector banks such as SBI, PNB, BoB and big private players such as HDFC Bank, ICICI and Axis Bank. Very soon, one can buy these bonds through RBI introduced retail portal, which will be launched later this year.