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Additional deduction with infra bonds

Additional deduction with infra bonds
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First Published: Thu, Feb 03 2011. 10 18 PM IST
Updated: Thu, Feb 03 2011. 10 18 PM IST
Infrastructure bonds got a boost last year when Budget 2010 carved out a separate tax deduction limit of Rs 20,000 under section 80CCF, in addition to the Rs 1 lakh limit already allowed under section 80C. As per the notification issued by the Central Board of Direct Taxes in July, the government appointed IFCI Ltd, Life Insurance Corp. of India (LIC), Infrastructure Development Finance Co. Ltd (IDFC) and any non-banking financial company, classified as an infrastructure finance company by the Reserve Bank of India to issue these bonds.
Also See Basic Features (PDF)
So far, IFCI, IDFC and L&T Infrastructure Finance Co. Ltd have issued two tranches, each, of their bonds. While India Infrastructure Finance Co. Ltd’s (IIFCL) first tranche of bonds opens on Friday, L&T infra bond’s second tranche opens on 7 February.
What are infrastructure bonds?
Classified as long-term infrastructure bonds, these are 10- to 15-year debt instruments. Just like a typical loan, these companies borrow money from investors by issuing bonds (to be repaid at a later date) and then lend this money to infrastructure projects.
Since the money is to be lent to finance infrastructure projects and such projects have a large gestation period (time taken for projects to get completed and to start making money, thereafter), the government attached a longer tenor to these bonds. To make things a bit easier though, these bonds are allowed to give a buy-back option after five years; the minimum lock-in period. You may choose to ignore the buy-back option and stay invested throughout the tenor.
What do they offer?
As per the Reserve Bank of India’s notification, these bonds cannot offer an interest rate that is higher than the 10-year government security interest rate as per the last closing day of the month preceding the one in which the bond issue hits the market. For instance, if the issue hits the market on 4 February, it can offer a maximum interest rate equivalent to the 10-year government security interest rate as on 31 January (previous month closing). Since the 10-year government security has oscillated between 7.9% and 8.2% in the last quarter of 2010, the interest rates on offer have also been in the same range.
While L&T Infrastructure Finance bonds offered 7.5% and 7.75% between four options, IDFC bonds offered 7.5% and 8% between four options, in the first tranche and 8% in its second tranche.
On account of a slight increase in 10-year government security in the recent months, the new set of infra bonds are offering higher interest rates. IIFCL bonds offers a coupon rate of 8.15% and 8.30% for a 10- and 15-year option, respectively, L&T infra bond’s second tranche offers between 8.20% and 8.30% for a pair of 10-year options.
Apart from a choice of getting an annual interest payment option and a cumulative option, you also get a choice to apply in the dematerialized and physical mode.
Says Anish Arora, head (third party products distribution), Nirmal Bang Securities Ltd, a Mumbai-based distribution house: “Investors who have exhausted their section 80C investments can look at infrastructure bonds and exhaust their Rs 20,000 limit under section 80CCF.”
Pre- and post-tax returns
Though these bonds offer modest returns compared with some of the other options—such as what bank fixed offer at present—its post-tax yield is quite high.
For instance, back-of-the-envelope calculations show that the post-tax adjusted yields turn out between 9% for investors in lower tax bracket and about 17-18% for investors in the highest tax bracket. The reason behind these high yields is the way post-tax returns are calculated keeping in mind the tax you save at the time of your investment (depending on your income-tax bracket) and the tax that you pay on your interest income.
Says Vikram Limaye, executive director, IDFC: “Tax-adjusted yields are in a way similar to equity returns. It’s important to account for the post-tax yields in addition to the actual coupon rate.”
Should you invest
Despite high returns, not all infrastructure bonds are worthy of your investment. Here’s what you should look out for.
Opt for the buy-back option: Gautam Nayak, partner, Contractor, Nayak and Kishnadwala Chartered Accountants, a Mumbai-based chartered accountancy firm, suggests a shorter tenor is always preferable. “It’s good to get the money sooner rather than later,” he adds.
L&T infra bond’s second tranche offers a buy-back after five and seven years, in both its options (annual and cumulative). While the five-year buy-back option offers a post-tax yield of 18.10% (annual) and 16.61% (cumulative) for investors in the highest tax bracket, the seven-year buy-back option offers a post-tax yield of 15.81% (annual) and 14.17% (cumulative). If, on the other hand, you decide to stay till maturity (10 years), the annual option earns you a post-tax yield of 14.16% and the cumulative option earns you 12.38%.
Credit rating: Since infrastructure bonds are long-term in nature, it’s important that you stick with a company that is highly rated and comes with good pedigree. While IDFC infra bonds were rated AAA by rating agencies such as Icra and Fitch, L&T infra bonds are rated AA+ by rating agencies such as Care and Icra.
It’s not just the credit rating, but also the rating agency that matters. For instance, while rating agencies such as Icra, Fitch and Care have a track record behind them, IFCI Long Term Infrastructure Bond–Series 1 was rated by a relatively new credit rating agency called Brickwork Ratings India Ltd, which doesn’t inspire much confidence.
Section 54EC bonds
If you’ve made long-term capital gains (LTCG) of up to Rs 50 lakh on real estate, you can save tax by investing in bonds specified under section 54 EC of the Income-tax Act. At present, you can invest in bonds from Rural Electrification Corp. Ltd and National Highways Authority of India.
Keep in mind that these bonds are available till 31 March. But the issuers of the bond have the right to close the issue any time before this date. To download the forms, visit www.nhai.org and www.recindia.nic.in or collect them from authorized banks. Both the bonds carry a maturity of three years.
Currently, both the bonds give an interest rate (coupon rate) of 6%, payable annually. You can invest a minimum of Rs 10,000 and a maximum of Rs 50 lakh. The face value is Rs 10,000 per bond and you can buy up to 500 bonds. The good thing about these bonds is that no tax is deductible at source on the interest they pay. But the interest earned on these bonds is taxable.
Should you invest: Yes, if you have sold a property and wish to reinvest the proceeds instead of buying a second property. But remember to invest the capital gains in these bonds within six months of booking profits in order to be eligible to the claim.
Tip: You can invest a maximum of Rs 50 lakh in one fiscal year and that too within six months of the transfer of the asset. However, you can increase your benefit if your LTCG exceeds Rs 50 lakh if you book your profits between October and March of any year since the six-month period will cover two fiscal years—one ending in March and the other starting April.
Let’s say, an LTCG of Rs 1 crore arises in the month of, say, January, you can invest Rs 50 lakh till 31 March and can invest the remaining Rs 50 lakh in April, when the next fiscal year starts. The investment limit is for one year, but the exemption is not limited per year.
Illustration by Jayachandran; graphic by Yogesh Kumar/Mint
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First Published: Thu, Feb 03 2011. 10 18 PM IST