Effective return on infra bonds is 14.3%

As readers may be aware, in the budget for 2010-11, the finance minister announced a new deduction (under Section 80CCF) of Rs20,000 for investment in special infrastructure-related bonds. This deduction is over and above the Rs1 lakh deduction permitted under Section 80C.

The first issue of such bonds has now been launched by IFCI Ltd. Following are some of the salient features of these bonds:

Though the term of the bond is ten years, there is an option to exit after five years. So the minimum lock-in period 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 7.85% per annum for bonds with a five year lock-in and 7.95% for bonds with a ten-year lock-in. You may choose either the regular interest or the cumulative option. The interest received is fully taxable. However, there would be no tax deduction at source (TDS) applied.

The bonds will be compulsorily issued in the demat mode, so investors without a demat account will not be eligible. The application has to be made in the same order as appears in the demat account.

For example, in case of a single applicant, the demat account would also have to be held in the name of the same single applicant and so on. Having a PAN card is also mandatory for subscribing to these bonds.

Though there is no maximum limit for investment, tax deduction is only available up to Rs20,000.
The provisions of the Direct Tax Code (DTC) are extremely relevant in the case of these bonds.

The revised discussion paper on the DTC released by the Central Board of Direct Taxes (CBDT) specifically provides that any investments 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 that method of tax treatment for the full duration of the financial instrument.

In other words, the exempt-exempt-taxed (EET) regime would be applicable only prospectively. What this means is that since these 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 with a five-year holding period is 7.85% per annum, the real effective rate is much higher. In case of individuals who fall in the 30% tax bracket, the effective post-tax return is as high as 14.30% per annum!

This is primarily because of the tax deduction. Remember that the initial investment saves tax. And since a penny saved is a penny earned, the savings in tax payable works akin to having invested that much lesser in the first place. For someone in the 30% tax bracket, the tax outgo will be lower by Rs6,000 (Rs20,000 x 30%).

This jacks up the effective return. The return for persons who fall in the 10% and 20% tax brackets works out to 9.68% per annum and 11.80% per annum respectively. This is almost like saving tax and getting paid for it. So you should apply for these bonds by all means.

Though IFCI’s issue closes on August 31, there would be more such issues before the end of the fiscal as there are other institutions waiting to launch their own schemes.

Another notable point is that in all probability, this year is the limited window for these bonds. The DTC (as announced) has no room for Section 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 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 this fiscal. So do make hay while the sun shines.

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