Tuesday, September 28, 2010

Infrastructure Bonds - A sneak peek

The Budget for the fiscal 2010-11 introduced infrastructure bonds to facilitate financing of long gestation infrastructure projects. The government has notified an investment of up to Rs 20,000 in these bonds to be exempt from income tax over and above the Rs 1 lakh tax exemption under section 80C of the Income Tax Act.  This should result in an additional tax saving of Rs 2,000 to Rs 6,000, depending on the tax slab applicable to each investor.

Structure of Infrastructure Bonds: Amount invested in infrastructure bonds will be used to finance various infrastructure projects in the country. As per the specifications of the central government, infrastructure bonds are to be issued by IFCI, LIC, IDFC and any non-banking infrastructure finance company recognised by the Reserve Bank of India.

While IFCI has recently closed its issue of infrastructure bonds, LIC and IDFC are now set to launch their issues in coming months. The tenure for these bonds is 10 years with a lock-in period of five years. Thus, after a period of 5 years, the issuing company can buy back these bonds from investors.

Alternatively, the investor can choose to trade these bonds in stock exchanges. The issuing company shall offer two rates of interest on these bonds — one is when the investor chooses the buy-back option after the lock-in period and the other is when he chooses to hold on to the investment till maturity period.

Returns and Tax Treatment

Infrastructure bonds will carry an interest rate, which will be determined by the issuing company. The central government, however, has notified that the interest rate so payable shall not exceed the yield on 10-year government bonds. As the current yield on 10-year government bonds is around 8%, investors can expect these infrastructure bonds to offer a rate marginally lower than 8%.

IFCI, for instance, had offered investors an interest rate of 7.85% for bonds with a buyback option after 5 years and 7.95% for bonds without the buyback option and redeemable after 10 years. IDFC, whose bonds have hit the market yesterday (click here), is likely to offer an interest rate ranging from 7.5- 8%.

Investors can opt for either an annual payout of interest or allow the same to be compounded annually and payable only on maturity. Though the principal amount of investment — up to Rs 20,000 — is exempt from tax, the investor shall be liable to pay tax on the amount of interest earned from such an investment. If the investor chooses to trade these bonds in the exchanges after the lock-in period, any gains accrued thereon shall also be subject to long-term capital gains tax.

5-year Tax Saving Bank FD v/s Infrastructure Bonds

As infrastructure bonds have a lock-in period similar to that of a tax saving bank fixed deposit and are expected to offer interest rates similar to the ones being currently offered by banks on their fixed deposits, it is very natural for investors to contemplate as to which one of the two is a better tax-saving avenue.

A 5-year tax saving bank FD is part of the existing 80C basket with a maximum exemption limit of Rs 1 lakh, an investment in infrastructure bonds is an additional exemption of Rs 20,000.

Thus, in case you have already exhausted the exemption limit of Rs 1 lakh through investments in Public Provident Fund (PPF), Employee Provident Fund (EPF), LIC Premium, Repayment of Principal on housing loan etc., you have to opt for infrastructure bonds rather than bank FDs.

As far as the returns from these two instruments are concerned, let us assume an interest rate of 7.85% (as offered by IFCI) for the 5-year infrastructure bond (with buy-back option) and an interest rate of 7.5% on a 5-year tax saving bank FD — as is the prevailing interest rate being offered by most banks.

Thing to note here is that the interest in case of a bank FD is compounded quarterly, but is annual for infrastructure bonds.

Given the above interest rates, an investment of Rs 20,000 shall fetch a pre-tax interest income of Rs 8,999 in the case of the bank FD and Rs 9,183 in the case of infrastructure bonds after a period of 5 years. Thus, it is not the yield on maturity, but the benefit accruing at the time of investment that needs to be considered before making an investment decision.

Risk Element: While there is no risk as far as the underlying asset of these investments is concerned, the embedded risk lies with respect to the institution offering these bonds. It is thus important for investors to carefully scrutinise the credibility of the institution offering these bonds. Moreover, there is still an uncertainity on the future of this mode of investment since with DTC in 2012, there is no mention of these bonds.

There are various articles on internet on this -

  1. Economic Times
  2. Rediff.com


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