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Tax 10-11: Should you invest in Infrastructure Bonds?

(Guest)

One of the fresh tax reliefs that has come as an outcome of the budget2010 is the deduction allowed for investing upto Rs 20000 in the infrastructure bonds.

Many articles and the FM have said that this is a very positive thing. But how can the same thing be positive for every individual. If not negative it should at least be neutral for many.

Full article on www.forum4finance.com

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7 Replies

Rajat Singhal CA,CS,CFA (Senior Manager (F&A)) (254 Points)
Replied 10 March 2010

Hello Mita,

These bonds may be positive because these would be risk free as notified by the central govt.

Secondly, there will be additional deduction of Rs. 20000.

Regards

Rajat

Ramesh (Manager - Finance & Accounts) (92 Points)
Replied 10 March 2010

What is the Rate of Interest for Infra. Bond

Rajat Singhal CA,CS,CFA (Senior Manager (F&A)) (254 Points)
Replied 10 March 2010

Dear Freinds,

This provides an additional investment and tax-saving avenue for investors. The total savings limit for individuals is now Rs 1.2 lakhs. By investing in infrastructure or tax-saving bonds, you can save on taxes as provided under the Income Tax Act 1961.

Two important factors playing a vital role while choosing infrastructure bonds to invest in are inflation and interest rate movements . For instance, the price of a bond will fall if interest rates rise and vice versa.

Infrastructure bonds reduce your tax liability. You have the option of purchasing and holding the instruments either as physical certificates or in the demat form. These come in two categories - regular interest or deep discount bonds. These bonds are issued at a discount . After the tenure, they are redeemed at their face value. A zero-coupon bond has no coupons attached and there is no interest paid. But at maturity, the issuer promises to redeem the bond at face value. The maturity dates on zero coupon bonds are usually long-term . Many don't mature for 10 or more years. These long-term maturity dates allow an investor to plan for a longrange goal, such as paying for a child's college education .

With the deep discount bond, an investor can set aside a small amount of money that can grow over many years. Obviously, the original cost of a Rs 1,000 bond is much lesser than Rs 1,000. The actual price depends on the holding period - the number of years to maturity, the prevailing interest rates, and the risk involved (for the bond issuer). In order to find the yield of the bond, you need to consider the par value, the purchase price and the time until maturity. Infrastructure bonds do not offer any protection against high inflation since the rate of interest they offer is predetermined. These can be pledged with a bank to borrow. The amount you can get depends on the market value of the bond and the credit quality of the instrument .

Some key features of these bonds:

The motive behind investing in infrastructure bonds is to save tax. Investments in other products like mutual funds are market-linked and returns are not assured, and thus the rate of returns may not be repeated in the future. The risks associated with mutual fund investments are much higher as compared with these bonds. Investors who want to invest in risk-free avenues might be unwilling to venture into market-linked products.

How it works for you :

Considering the tax savings , the effective yield on these bonds comes out to be quite good. In case you invest Rs 20,000, in these bonds, you can claim a deduction of Rs 20,000 in addition to the Section 80C deduction. At the highest tax rate of 30 percent , this translates into a saving of Rs 6,000 in taxes, which is available upfront.

In case the interest rate offered is eight percent, you will get interest on Rs 20,000 i.e. Rs 1,600. However, this would be on a net investment of Rs 14,000 (considering the tax benefit). As such, the net yield is 11.43 percent (Rs 1,600 divided by Rs 14,000). It is to be kept in mind that the interest earned may or may not be tax-free . Usually, the interest earned is taxable in the hands of the individual.

Regards

Rajat