Feb to March is the most active period with respect to tax planning. Most of the earning community is busy with exploring different type of tax saving options. Tax is such a dreaded word that it makes both rich and poor dance to its tunes. Irony is Income Tax daemon is harsher towards rich people who otherwise have all the powers. The more you earn the more you are liable to pay as taxes. There is no way out of this trap but surely there are some consolation prizes for the investor community.

One of them has been provided to you in Union Budget 2010-11 by introduction of a new tax saving scheme – Infrastructure Bond Investment. Tax saving using Infrastructure bonds is not new and it was available till 2005-06 for retail investors like you. For most of people Tax planning is equivalent to confusion and complexity. Various investment avenues available require their own share of research so as to maximize the tax savings. Keeping this constraint of individual investor in mind let’s try to understand what infrastructure bonds are and how to benefit from investing in the currently open schemes.

 

What Are Tax Saving Infrastructure Bonds?

Infrastructure bonds are issued by government or nongovernment institutions to fund crucial infrastructure projects related to transportation, electricity generation and other public facilities. These developments are of immense importance from countries economic growth perspective. As tax advantages are associated with these bonds funding is available at lower interest rates.

 

Why should you invest in Infrastructure Bond?

One should invest in these bonds as it increases the limit of Tax Exemption from Rs1 Lakh to Rs1.2 Lakh under section 80(C). The investment in these Tax Free Infrastructure Bonds are considered to be a part of section 80(C), but the 20,000 amount which comes under 80CCF will be treated over and above the 80(C) limit of Rs1 Lakh. As this extra 20000 investment is reserved only for infrastructure bonds and not for any other tax saving instrument it’s worth consideration as an investment option.

 

Example - Limit of investment and the amount of Tax you save

Even though there is no limit on amount you want to invest in these bonds, you get onetime tax benefit only on initial RS 20000 invested in these bonds.

Let’s take example of Harish who is planning to buy infrastructure bond to save tax –

 

Harish’s Tax Bracket

T

30%

Investment Amount

A

20000

Interest Payment of Bond

R

9% per year

Lock In Period

P

5 years

 

Income Calculation

Let’s say Harish invests RS 20000 in infrastructure bonds to save tax and he sells his bond holding after 5 years. So

Harish Tax saving = T * A = 30% * 20000 = 6000

Harish earning from Bond Interest Payment = R * P * A = 9% * 5 * 20000 = 9000

Harish total income for 5 years = 6000 + 9000 = 15000

Harish % return for 5 years = 15000/20000 = 75%

Harish % return per year = 75/5 = 15%

 

What if he invests more than 20000?

Let’s say Harish initially invests 40000 in the bond rather than 20000. By doing so he will have no extra tax saving as the tax saving is only applicable for maximum investment of 20000. He still saves 6000 in taxes but earns in the form of Bond Interest Payment on additional investment as calculated above.

 

What are the Options Available and how to differentiate between them?

Currently the REC Infra Bondsissue is open and you can find details regarding some of the features of bond below. Even if you were not able to invest in previous issues like IDFC, IFCI, L&T etc do not lose hope. There will be multiple issues right till the end of the financial year and you can invest in any of them till 31st of March.

How to choose the best one?

Most of the features like tenure, buy back option, minimum investment, and exit option are almost common for all the offers and hence cannot be used as differentiators. The main features which you should focus on are

      1. Interest Rate – The more the better
      2. Credit Rating – The higher the rating the better the option is
      3. Financial Health of the issuer – This is the most important one and never compromise with the financial position of the issuer. It’s a long term investment so issuer should be fundamentally strong.
      4. Government Backing – You should also consider the support available to the issuer from the government. It makes the investment more secure.

 

REC Long Term Infrastructure Bond 2011-2012 features

 

REC Long Term Infrastructure Bond

Offering

Issue Closes On

10-Feb-12

Term Of Bond

10 Years/15 Years

Minimum Investment

5,000

Rating

AAA

Lock-in or Maturity Period

5 years

Interest Rate

8.95%(10 Yrs ) / 9.15%(15 Yrs)

Interest Payment

Yearly/Cumulative

Exit Option

Callable after 5 years

 

How appropriate this investment option is?

As the interest income of Infrastructure bonds is taxable the effective return on this investment generally ranges from 5 to 8% which might be slightly lower than return on safer investment options like PPF, NSC, Fixed deposit etc. Although it’s a safe investment it doesn’t protect you against inflation (approximate return is round 5 to 8%) and is highly illiquid till the lock in period (5 years). As the interest which you earn on these bonds is also not Tax Free it’s advisable to use this option only for tax saving purpose i.e. maximum investment of Rs20000.

 

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