After discontinuing tax-saving bonds last Budget, the finance ministry might now draw the curtains on tax-free bonds, designed to encourage long-term investments in the infrastructure sector. Tax-free bonds are those bonds issued for long term, for investment horizon of 10 to 15 years, in which interest earned is exempt from tax. Tax-free bonds do not provide any benefit of tax savings but only interest earned on these bonds is tax exempt. Since there is no tax on interest earned, these bonds are touted as much more attractive than bank fixed deposits.
General Features of Tax-free bonds:
(i) Tenor of Bonds: The tenor of the bonds shall be for 10 or 15 years.
(ii) Permanent Account Number: It shall be mandatory for the subscribers of such bonds to furnish their permanent account number to the issuer.
(iii) Registration with Issuer: The benefit under the said section shall be admissible only if the holder of such bonds registers his or her name and holding with the issuer.
(iv) Rate of Interest:-
(a) There shall be a ceiling on the coupon rates based on the reference Government Security (G-Sec) Rate. The reference G-Sec Rate would be the average of the base yield of G-Sec for equivalent maturity reported by Fixed Income Money Market and Derivatives Association of India (FIMMDA) on daily basis (working day) prevailing for two weeks ending on the Friday immediately preceding the filling of final prospectus with the Exchange or Registrar of Companies (ROC) in case of public issue and the issue opening date in case of private placement.
(b) The ceiling coupon rate for AA rated issuers shall be the reference G-Sec Rate less basis points in case of Retail Individual Investors (RII); and reference G-Sec less 100 basis points in case of other investors segment , like Qualified Institutional Buyers (QIBs), Corporate and High Net Worth Individuals (HNIs);
(c) In case the rating of the issuers entity is above AA , a reduction of 15 basis points shall be made in the ceiling rate compared to the ceiling rate for AA rated entities [as given in clause (a)];
(d) These ceiling rates shall apply for annual payment of interest and in case the schedule of interest payments is altered to semi-annual, the interest rates shall be reduced by 15 basis points;
(e) Interest Rate on transfer of Bonds: The higher rate of interest , applicable to retail investors, shall not be available in case the bonds are transferred , except in the case of transfer to legal heir in the event of death of the original investor;
(v) Minimum ceiling for Public Issue, Issue Expenses and Brokerages:
(a) At least 75% of the aggregate amount of bonds shall be raised through public issue. 40% of such public issue shall be earmarked for retail investors;.
(b) Total issue expenses shall not exceed 0.5% of the issue size in case of public issue. The issue expenses would include all expenses relating to the issue like brokerages, advertisement, printing, registration, etc.
(c) The brokerage, in cases of different categories, shall be limited to the following ceilings:
Corporates – 0.1%
Tax Treatment under Various Heads and Sections:
1. Interest Exempt from Tax
a) Income do not form part of total income: Section 10(15)(iv)(h) to be read with Section 14A(1) provides that in computing the total income of a previous year of any person, interest payable by any Public Sector Company in respect of such bonds or debentures and subject to such conditions, including the condition that the holder of such bonds or debentures registers his name and the holding with that company, as the Central Government may, by notification in the Official Gazette, specify in this behalf shall not be included.
Further, as per Section 14 A (1), no deduction shall be allowed in respect of expenditure by the assesee in relation to said interest, being exempt.
b) TDS: Since the interest Income on these bonds is exempt, no Tax Deduction at Source is required. However, interest on application money would be liable for TDS as well as Tax as per present tax rules.
2. Capital Gain
a) Under section 2 (29A) of the I.T. Act, read with section 2 (42A) of the I.T. Act, a listed Bond is treated as a long term capital asset if the same is held for more than 12 months immediately preceding the date of its transfer.
Under section 112 of the I.T. Act, capital gains arising on the transfer of long term capital assets being listed securities are subject to tax at the rate of 20% of capital gains calculated after reducing indexed cost of acquisition or 10% of capital gains without indexation of the cost of acquisition. The capital gains will be computed by deducting expenditure incurred in connection with such transfer and cost of acquisition/indexed cost of acquisition of the bonds from the sale consideration.
However as per third proviso to Section 48 of Income Tax Act, 1961 benefits of indexation of cost of acquisition under second proviso of section 48 of Income tax Act, 1961 is not available in case of bonds and debenture, except capital indexed bonds. Thus, long term capital gain tax can be considered 10% on listed bonds without indexation.
Securities Transaction Tax (“STT”) is a tax being levied on all transactions in specified securities done on the stock exchanges at rates prescribed by the Central Government from time to time. STT is not applicable on transactions in the Bonds.
In case of an individual or HUF, being a resident, where the total income as reduced by the long term capital gains is below the maximum amount not chargeable to tax i.e. Rs 200,000 in case of all individuals including resident women, Rs 250,000 in case of resident senior citizens and Rs.500,000 in case of resident very senior citizens, the long term capital gains shall be reduced by the amount by which the total income as so reduced falls short of the maximum amount which is not chargeable to income-tax and the tax on the balance of such long-term capital gains shall be computed at the rate of ten per cent in accordance with and the proviso to sub-section (1) of section 112 of the I.T. Act read with CBDT Circular 721 dated September 13, 1995.
A 2% Education cess and 1% Secondary higher education cess on the total income tax (including surcharge for corporate only) is payable by all categories of tax payers. All the rates disclose above are taken as per the present tax rates.
b) Short-term capital gains on the transfer of listed bonds, where bonds are held for a period of not more than 12 months would be taxed at the normal rates of tax in accordance with and subject to the provision of the I.T. Act.
The provisions related to minimum amount not chargeable to tax, Surcharge and Education cess described at (a) above would also apply to such short-term capital gains.
c) Under section 54 EC of the Act and subject to the conditions and to the extent specified therein at present, long term capital gains arising to the bondholders on transfer of their bonds in the company shall not be chargeable to tax to the extent such capital gains are invested in certain notified bonds within 6 months from the date of transfer. If only part of the capital gain is so invested, the exemption shall be proportionately reduced. However, if the said notified bonds are transferred or converted into money within a period of 3 years from their date of acquisition, the amount of capital gains exempted earlier would become chargeable to tax as long term capital gains in the year in which the bonds are transferred or converted into money. Where the benefit of section 54 EC of the Act has been availed of on investments in the notified bonds, a deduction from the income with reference to such cost shall not be allowed under section 80 C of the Act. The investment made in the notified bonds by an assessee in any financial year cannot exceed Rs. 50 Lakh.
d) As per the provisions of Section 54F of the Income Tax Act, 1961 and subject to conditions specified therein, any long term capital gains (not being residential house) arising to Bond Holder who is an Individual or Hindu Undivided Family, are exempt from capital gains tax if the entire net sales consideration is utilised, within a period of one year before, or two year after the date of transfer, in purchase of new residential house, or for construction of residential house within 3 years from the date of transfer. If part of such net sales consideration is invested within the prescribed period in the residential house, then such gains would be chargeable to tax on a proportionate basis.
e) Under section 195 of the Income Tax Act, Income tax shall be deducted from sum payable to non residents on the long term capital gain and short term capital gain arising on sale and purchase of bonds at the rate specified in the Finance Act of the relevant year or the rate or rates of the income tax specified in an agreement entered into by the Central Government under section 90, or an agreement notified by the Central Government under section 90A, as the case may be.
However under section 196D, No deduction of tax shall be made from income arising by way of capital gain to Foreign Institutional Investors.
3. Profit and Loss
In case the Bonds are held as stock in trade, the income on transfer of bonds would be taxed as business income or loss / capital gain or loss in accordance with and subject to the provisions of the Income Tax Act applicable time to time.
4. Taxation on Gift
As per section 56(2)(vii) of the Income Tax Act, in case where Individual or Hindu Undivided Family receives bond from any person on or after 1st October, 2009
a. without any consideration, aggregate fair market value of which exceeds fifty thousand rupees, then the whole of the aggregate fair market value of such bonds/debentures or;
b. for a consideration which is less than the aggregate fair market value of the Bond by an amount exceeding fifty thousand rupees, then the aggregate fair market value of such property as exceeds such consideration; shall be taxable as the income of the recipient.
Provided further that this clause shall not apply to any sum of money or any property received—
(a) From any relative; or
(b) On the occasion of the marriage of the individual; or
(c) Under a will or by way of inheritance; or
(d) In contemplation of death of the payer or donor, as the case may be; or
(e) From any local authority as defined in the Explanation to clause (20) of section 10; or
(f) From any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in clause (23C) of section 10; or
(g) From any trust or institution registered under section 12AA.
Wealth-tax is not levied on investment in bond under section 2(ea) of the Wealth-Tax Act, 1957.
Today, it is difficult to get more than 9%p.a for long-term fixed deposits (FDs) from banks. Those earning more than Rs10 lakh annually are in the highest tax bracket (30%). This means that effective post-tax return from long-term FDs is only 6.3%. AAA rated tax-free bonds giving 7.86% are much better option.