Grab infra bonds before new tax code kicks in

In Budget 2010 the finance minister had announced a new deduction (Sec 80CCF) of Rs20,000 for investment in special infrastructure related bonds.

This newly announced deduction is over and above the Rs1 lakh Sec 80C deduction. Since then, issuers such as IDFC, IFCI, Rural Electrification Corp and Larsen & Toubro have been issuing bonds that offer this deduction. The current issue of L&T Infrastructure Bonds which opened on November 25 is due to close on December 24. Every taxpayer, regardless of his income level or tax bracket would do well to invest in these bonds. Here’s why. Though the term of the bond is 10 years, there is an option to exit after five and seven years. So the minimum lock-in is five years after which the investor may exit either through the secondary market or through a buyback facility provided by the issuer.

The interest rate is 9% per annum (pa) and you may choose either the regular interest or the cumulative option. Though one may invest an additional amount, the tax deduction would be applicable only to the extent of Rs20,000. To be listed on the Bombay Stock Exchange (BSE), the bonds carry a rating of AA+ from CARE and Icra. The minimum application amount is fixed at Rs5,000.

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 (CBDT) specifically provides that any investments made before the date of commencement of the DTC in instruments which enjoy EEE (exempt, exempt, exempt) method of taxation under the current law would continue to be eligible for EEE method of tax treatment for the full duration of the financial instrument.

In other words, the exempt-exempt-tax (EET) regime of taxation would be applicable only prospectively. What this means is that since these 80CCF bonds are being issued before the DTC is 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 9% pa, 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 15.55% pa.

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  10.84% pa and 13% pa, respectively.

However, in this regard also a note of caution. I have come across advertisements and promotions that declare even higher returns for this instrument than what have been mentioned above. This is patently misleading. The rate of return is as mentioned in the article and that too this is effective return i.e. something that emerges on account of the upfront tax deduction on invested capital. Without this deduction, the yield will be the same as the coupon rate i.e. 9% pa before tax. In other words, for any investment over and above Rs20,000 the investor stands to earn 9% only — a bank deposit currently would yield a higher rate!

However, to the extent of Rs20,000, it is almost like saving tax and getting paid for it, regardless to which tax bracket the investor belongs to (obviously the higher the better). So go for it by all means. The issue closes on December 24. Though there could be another issue before the end of the fiscal, its better not to risk waiting till the last minute.

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 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, 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. So do avail of this tax saving opportunity as long as it is made available.

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