Things you need to know about tax-free bonds

National Highways Authority ofIndia (NHAI) is set to raise Rs10,000 crore through the sale of tax-free bonds. The issue opens for subscription from 17th December to 31st December. Thepaper offers 7.39 to 7.6 per cent interest with 10-15 years maturities.

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Tax free bonds are emerging as apopular choice for investors. Last week only IRFC got bids worth Rs 10,000crore, which was double the application size it applied for.  Many moretax-free bonds are expected to hit the market as the financial year draws to aclose.

Here is a low down to help youunderstand what all is offered by tax free bonds.

1) Compared with FDs, tax-freebonds comes with longer maturities of 10, 15 and 20 years.

2) Most importantly, unlike FDsthe interest income is tax-free in such bonds. Therefore, the effective yieldin tax free bonds is higher than FDs. Consider this  : the effective yieldon 7.6% 15-year NHAI bonds for an individual in the 30.9% tax bracket is 11%.Similarly, for 10 years the effective yield on 7.39 per cent comes out to 10.69per cent in the 30.9% tax bracket. 

3) Tax-free bonds works best forpeople in higher tax brackets.  You can expect stable return from suchbonds in the long run as they lock in return for 10, 15 and 20 yearsirrespective of the interest rate moving down.

4) These bonds are not eligible for deduction under section80C of the Income Tax Act. Moreover, short-term capital gains are taxed atnormal income tax rates while long-term capital gains (from sale of bonds aftermore than one year) are taxed at 10% based on indexation

5) You are paid interest annuallyand on maturity the principal amount is paid back. But selling bonds beforematurity may not offer you required amount as it depends on market conditions.

7) As the government is movingtowards paperless transactions you can apply in physical as well as demat formfor these bonds.

8) Tax-free bonds are tradable onBSE and NSE. Once it gets listed on the exchange you can sell them off if thereis need for money.

9) Tax-free bonds are rated bycredit rating agencies such as  ICRA, CRISIL, and CARE. These bondsgenerally assigned AAA ratings.

10) The price of  bondsvary  inversely  with  changes  in  prevailing interest  rates. This means when  interest  rates rise, pricesof fixed income securities fall and when interest rates drop, the pricesincrease.