New infrastructure bonds window may not open again after March 31

In Budget 2010, the finance minister had announced a new deduction (Sec 80CCF) of Rs20,000 for investment in special infrastructure related bonds. The deduction is over and above the Rs1 lakh Sec 80C deduction.

The current issue from IDFC, which has opened on January 17, is due to close on February 4.

Every taxpayer, regardless of income level or tax bracket, would do well to invest in these bonds up to a limit of Rs20,000. Here’s why.

Though the term of the bond is ten years, there is an option to exit after five years. So the minimum lock-in is five years and after the lock-in, the investor may exit either through the secondary market or through a buyback facility provided by the issuer.

The interest rate is 8% p.a. and you may choose either the regular interest or the cumulative option.

The interest received is fully taxable and tax deduction at source (TDS) would only be applicable for any interest above `2,500 per annum.

Incidentally, at 8% per annum, the interest on an investment of Rs20,000 would work out to Rs1,600 — an amount, which would be lower than the TDS limit.

Though one may invest an additional amount, the tax deduction would be applicable only to the extent of Rs20,000.

The bonds, to be listed on the NSE and BSE, carry a rating of LAAA from ICRA and AAA from FITCH, indicating high safety and a stable outlook.

The minimum application amount is fixed at Rs10,000, or two bonds.

Extremely relevant in the case of these bonds are the provisions of the Direct Taxes Code (DTC).

The revised discussion paper on the DTC released by the Central Board of Direct Taxes specifically provides that any investment made before the date of commencement of the DTC, in instruments which enjoy the exempt-exempt-exempt (EEE) method of taxation under the current law, would continue to be eligible for the EEE method of tax treatment for the full duration of the financial instrument.

In other words, the exempt-exempt-taxed (EET) regime of taxation would be applicable only prospectively.

This means, since the 80CCF bonds are being issued before the DTC has been made operational, even if the maturity proceeds are received during the DTC regime, the same would continue to remain tax-free.

This has enormous implications for investors in terms of the effective return on the bonds. For example, though the nominal return for bonds is 8% per annum, the real effective rate is much higher. In case of individuals who fall in the 30.9% tax bracket, the effective post-tax return is as high as 14.67% per annum.

This is primarily because of the tax deduction. Remember that the initial investment saves you tax. And since a penny saved is a penny earned, the saving in tax payable works akin to having invested that much lesser in the first place. For someone in the 30.9% tax bracket, the tax outgo will be lower by Rs6,180 (Rs20,000 x 30.9%). This jacks up the effective return. The effective return in the 10.3% and 20.6% tax bracket works out to 9.88% per annum and 12.07% per annum, respectively. However, in this regard I also need to sound a note of caution. I have come across advertisements and media reports about even higher returns than what have been mentioned above. Note that this return is effective return i.e something that emerges on account of the upfront tax deduction. Without the deduction, the yield will be the same as the coupon rate i.e 8% p.a. before tax. In other words, for any investment over and above Rs20,000 the investor stands to earn 8% only - a bank deposit currently would yield a higher rate!

But till Rs20,000, it is almost like saving tax and getting paid for it. So go for it by all means. Though there could be another issue before the end of the fiscal, it is better not to risk waiting till the last minute.

Also, in all probability, this year is the limited window for these bonds. The DTC (as announced) has no room for Sec 80CCF and consequently, this deduction may not be available next year.

At a time when there is a dearth of good fixed income avenues to invest in, these bonds with their high effective rate could prove to be extremely useful for the fixed income allocation in your portfolio.

Moreover, as explained above, so long as the initial investment has been made before the advent of DTC, the maturity amount will continue to be tax-free even in the DTC regime However, this window will be open only till the end of the current fiscal year. So do make hay while the sun shines.

The writer is director, Wonderland Consultants, a tax and financial planning firm. He can be reached at sandeep.shanbhag@gmail.com