What are tax-free bonds, and how can one invest in tax-free bonds?

• Follow

Do you want to put your money into a fixed-income instrument and avoid paying taxes on the interest you earn? Yes, it is doable if you’re buying tax-free bonds. Tax-free bonds are one of the most sought-after assets in the market because they offer zero tax on returns, among other advantages. Let’s take a look:

What are Tax-free bonds?

A government enterprise issues tax-free bonds to raise revenue for a specific purpose. Municipal bonds, for example, are a type of bond issued by municipal corporations. They have a fixed rate of interest and rarely default, making them a low-risk investment option.

As the name implies, the most appealing aspect is the absolute tax exemption on interest under Section 10 of the Income Tax Act of India, 1961.

Tax-free bonds are exempt from the requirement to pay income tax on interest income. Tax-free bonds do not require investors to pay tax on interest payments made half-yearly or annually, and there is no tax burden on the principle amount received at maturity.

Tax-free bonds often have a ten-year or more extended maturity period. The money raised from these bonds is invested in infrastructure and housing initiatives by the government.

When it comes to investment, a tax-free bond is nearly identical to a fixed deposit. A lump payment can be put into a tax-free bond with a fixed rate of interest for a set period. The principle is repaid to the investor at the end of the term. One can invest in these bonds that are listed on stock markets. The majority of these bonds have a good safety rating regarding receiving interest and principal amount on maturity.

What are various tax-free bonds available at present?

Many public sector undertakings that issue tax-free bonds are now listed on BSE and NSE exchanges. Some of the most well-known are the National Highways Authority of India, NTPC, Indian Railway Finance Corporation (IRFC) and Rural Electrification Corporation.

Other examples include the Housing and Urban Development Corporation, the Indian Renewable Energy Development Agency, Rural Electrification Limited, and the Power Finance Corporation. As a result, you should always check for authenticity before making a purchase.

Who should invest in Tax-Free Bonds?

Tax-free bonds are a great option for investors looking for a steady income stream, such as older citizens. Because government undertakings usually issue these bonds for a longer period, the danger of default is low, and you are guaranteed a fixed income for a longer period, typically 10 years or more.

The money raised through these bonds is invested in infrastructure and housing projects by government enterprises.

For investors in the highest tax bracket, tax-free bonds are the best option. Tax-free bonds are preferred by high-net-worth individuals, HUF members, trusts, co-operative banks, and qualified institutional investors.

As the bond-holder if you make profit by selling the bonds on the stock exchange, then Under Section 112, the profit you make after the sale is also taxed. As a result, capital gains earned after selling a bond before one year are taxable according to your tax bracket. That said, trading it after one year will result in a 10% long-term capital gains tax, and there will be no indexation benefit. To summarise, tax-free bonds provide tax-free income while posing a low risk.