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How to make the most of infrastructure bonds

 

 

 

THERE is an additional tax-saving option available for taxpayers this financial year (2010-11) in the form of investments in long-term infrastructure bonds. The introduction of these bonds was announced in the Union Budget in February and now guidelines for the issue of such bonds have been released.

These guidelines give an idea to taxpayers as to what they can expect in the coming months when these bond issues actually become available for investment and how they can actually make use of the available benefits.

Exclusive benefit: The Income Tax Act provides taxpayers a deduction of Rs 20,000 for investment in long-term infrastructure bonds. A deduction means a reduction in the taxable income of the individual.

For example, if a person earns a total income of Rs 530,000 and there is a deduction of Rs 80,000 available, the tax to be paid will be calculated on the net figure of Rs 450,000 (Rs 530,000-Rs 80,000).

The important thing is that this benefit is over and above the available standard deduction of Rs 100,000, which taxpayers are familiar with. The benefit for investments up to Rs 20,000 in infrastructure bonds is available under a separate Section, 80CCF. This small detail is important because when it comes to the Rs 100,000 benefit, this is available for the total figure consolidated under three different sections of the I-T Act.

This covers premium paid on pension plans (Section 80CCC), amounts contributed to the pension scheme of central government (Section 80CCD) and other eligible investments like contribution to provident fund, contribution to public provident fund, life insurance premium and investment in equity-linked

savings scheme ( Section 80C), among others.

Being housed in a separate section not only means the total benefit for the taxpayer will amount to a deduction of Rs 1.2 lakh if they make full use of it, but also that there is an exclusive element involved.

What this means is that if the investor does not invest Rs 20,000 in long-term infrastructure bonds, the benefit for the year is lost and there cannot be an investment in any other instrument to replace this.

This is not the case with the instruments in the Rs 100,000 bracket, where it is immaterial which instrument is used to complete the total.

Choices: In terms of choices, there is likely to be some leeway for taxpayers because there are several entities that will be eligible for issuing these bonds. They include Industrial Finance Corporation of India, Life Insurance Corporation of India, Infrastructure Development Finance Company and a non-banking finance company that is classified as an infrastructure company by the Reserve Bank of India.

Looking at the list, it is clear that there will be adequate choices to pick your investment option as and when issues from these entities hit the market.

What will make these bonds a bit unattractive is the fact that a sort of ceiling has been imposed on the returns that these bonds can offer. The yield on these bonds cannot exceed the yield on government securities of similar residual maturity as reported by the Fixed Income Money Market and Derivatives Association of India on the last working day of the previous month before the issue.

This will ensure that the yield offered is not higher than what is prevailing in the market. Since companies know that taxpayers have no choice but to invest in these bonds, the yield offered may tend to be on the lower side.

Taxability: Investment in these bonds will result in a tax benefit in the form of a deduction limited to Rs 20,000. The tax benefit depends on the tax bracket that an individual falls under. So a person in the 30 per cent tax bracket will save a maximum of Rs

6,000 (Rs 20,000 X 30 per cent without considering the education cess) while those in the 20 per cent bracket will save a maximum of Rs 4,000 in taxes.

However, there is another element of taxation that is often forgotten and this is the taxation of the income that is earned in the form of interest on this bond. This interest remains taxable. If one seeks to understand the post-tax yield, then one will need to subtract the tax paid on this return to arrive at the post-tax yield. For example a bond earning 7 per cent for a person in the 30 per cent tax bracket will return 4.9 per cent post tax.

Lock-in period: Another factor that will impact taxpayers in these bonds will be the long-term nature of the bonds. The minimum tenure of these bonds will be 10 years, which means they can even be for a longer duration.

This is understandable, considering that the fund will be used for infrastructure projects. Taxpayers are more concerned with the lock-in period that has been put at a minimum of five years. After this, one can exit only through the secondary market or a buyback announced by the issuer.

The buyback details, if any, will be specified at the time of the issue of the bonds.

Final decision: There are a number of factors that will influence the final decision on investing in these bonds, but this will be possible only when a particular issue hits the market.

There has to be a net benefit in terms of gains in the form of tax savings being higher than the interest rate (if any) earned on the investment compared with other options present in the market over the life time of the instrument.

 

 




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