Last Updated: Saturday, March 12, 2016

Top 10 Features of Tax-Free Bonds

Image: Tax free bonds_moneynbusiness.com_Top 10 Features_advantages_benefits_ of Tax-Free Bonds'Tax-Free Bonds' also known as 'Tax-Exempt Bonds' and 'Municipal Bonds' are issued by the government by offering tax free return to the investors along with many more advantages. Government usually offers Tax-Free Bonds/Municipal bonds to raise additional money for its infrastructural development needs. Due to the benefits they offer Tax free bonds have come out as a most loved investment option for investors looking for low risk. Particularly in an emerging economy like India, where we have limited choice of instruments to have tax-free income. The most popular tax free return instruments in India include PPF (Public Provident Fund) and Tax Free bonds. Here we have prepared a list of ten to know everything about such bonds.
Top 10 Features of Tax-Free Bonds
1Understanding Tax-free Bonds: 'Tax-Free Bonds' are generally issued by enterprises governed by the government with a promise to pay a fixed coupon rate (also known as interest rate) over a stipulated period of time. As Tax-free Bonds are invested in infrastructure and other projects, they have a long-maturity term  may be 10 years, 15 years, 20 years or even more.

2. Suitability: 'Tax-Free Bonds' are suitable for those investors who wants steady passive income annually and for those who do not need their capital back over a long period of time. 

3. Benefits of Tax Exemption: The return on account of interest generated on tax-free bonds is fully exempted from income tax i.e. an investor does not need to pay tax on its interest. In fact the interest availed from 'Tax-Free Bonds' does not form part of  total income of an individual. Neither there is any deduction of tax at source (TDS) from bondholders. However it should be noted that no such deduction would be available for the amount of investment.

4. Coupon (Interest) rate: One of the advantages of  'Tax-Free Bonds' is pre-fixed coupon (interest) rates  where these bonds are linked to the on-going rates of government securities. Therefore Tax-Free Bonds' become attractive where there is high interest rates in the financial system of an economy.

5. Payment of Interest : The interest payable on these bonds is usually paid annually and directly credited  in the bank account of the bondholder.

6. How does Fixed deposits (FDs) differ from 'Tax-Free Bonds' : The interest availed on Fixed deposits (FDs) with bank and other similar bonds are added to the gross total income of an investor which is taxed as per the income-tax slabs prevailing in an economy. As discussed above interest earned from 'Tax-Free Bonds' are not taxed, bondholders in higher tax slabs mostly earn a better post-tax return than that of Fixed deposits (FDs). But it should also be noted, the bank Fixed deposits (FDs) in terms of liquidity get a better score over 'Tax-Free Bonds' because these bonds have usually  a longer maturity period.

7. Low Credit risk: As tax-free bonds are usually issued by government-linked companies, the credit risk i.e. risk of non-repayment is very low or negligible.

8. Liquidity: The tax-free bonds are traded in the stock exchange(s) only after they are get listed, at the same time  investors in 'Tax-Free Bonds' may not enjoy high liquidity. Most of the 'Tax-Free Bonds' are of long-term maturity tenure.
9. Need of Demat Account: you need a demat account to invest in 'Tax-Free Bonds', however these bonds could be issued both in demat and physical mode, so one does not need demat account when he buys it in physical mode.

10. Capital Gain on 'Tax-Free Bonds' : Bondholders may buy and sell these 'Tax-Free Bonds' on the stock exchanges of the country. As discussed the interest availed on these bonds is tax-free but any profit during the course of sale it in the secondary market will be taxable under the head of Capital Gain. 

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(Disclaimer: I am not an expert on tax free bonds so investors are instructed to make their own assessment before acting on the information provided by this blog.)

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