Anything more will only earn the coupon rate with yields lower than those of bank deposits.
Every taxpayer, regardless of income level or tax bracket would do well to invest in the special infrastructure related bonds that can be availed under Section 80CCF. It offers a deduction over and above the Rs 1 lakh limit available under Section 80C deduction.
The finance minister (FM) had introduced a deduction of Rs 20,000 for investment under the section, in his budget speech of 2010. Issuers such as IDFC, IFCI, REC and L&T have since issued such bonds. Currently, the REC Long Term Infrastructure Bonds has opened since 19 December and is due to close on the 10 February 2012.
Investors have two options to invest in these bonds - one could either choose bonds with a 10 year maturity or with a 15 year maturity. For the 10 year maturity, the interest rate on offer is 8.95 per cent per annum (p.a) whereas it is 9.15 per cent p.a. for the series having a 15 year maturity. Similarly the minimum lock in period is 5 years and 7 years respectively for each series. In other words, though the term of the bonds is longer, there is an option to exit after five years and seven years respectively. After the lock in, the investor may exit either through the secondary market or through a buyback facility provided by the issuer. One 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 Rs 20,000. To be listed on the Bombay Stock Exchange (BSE) or National Stock Exchange (NSE) or both, the minimum application amount is fixed at Rs 5,000.
Extremely relevant in the case of these bonds are the provisions of the Direct Tax 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 exempt-exempt-exempt (EEE) 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-taxed (EET) regime of taxation 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.
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This has enormous implications for investors in terms of the effective return on the bonds. For example, though the nominal return for bonds is 8.95 per cent / 9.15 per cent p.a., the real effective rate is much higher. In case of individuals who fall in the 30.9 per cent tax bracket, the effective post-tax return for the 10 year bond is as high as 15.51 per cent p.a!! The corresponding rate for the 15 year bond works out to 13.38 per cent p.a.
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 per cent tax bracket, the tax outgo will be lower by Rs . 6,180 (Rs . 20,000 x 30.9 per cent). This jacks up the effective return. The accompanying table illustrates the effective returns per annum for different tax slabs.
However, a note of caution. In the past, for earlier bond issues of similar type, we have come across advertisements and promotions that declare higher returns than those arrived at using proper mathematical calculations. This is patently misleading.
The rate of return is as mentioned in the article and that too this is the IRR that is 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 that is 8.95 per cent or 9.15 per cent p.a. (as the case may be) before tax. In other words, for any investment over and above Rs 20,000 the investor stands to earn the coupon rate only - a bank deposit currently would yield a higher rate!
However, to the extent of Rs 20,000, it is almost like saving tax and getting paid for it, regardless of which tax bracket the investor belongs to (obviously the higher the better). So go for it by all means.
Though there could be another issue before the end of the fiscal, its better not to risk waiting till the last minute. Interest rates in all probability have peaked and would be on a decline in the future. For example, the earlier Section 80CCF bond issue from L&T that just closed on 24 December, offered a marginally higher rate of 9 per cent p.a. for a ten year maturity.
So one can never say, for the next issue, the interest rate could be even lower than what is being offered currently.
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 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. So do avail of this tax saving opportunity as long as it is made available.
The writer is Director, Wonderland Consultants