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Fixed Income

HUDCO and IRFC Bonds With Tax Free 8%+ Interest

When you invest in a fixed deposit, the interest you receive is taxed as income. At the highest tax bracket, you pay 30% on that interest. That means a bank FD that gives you 10%, really only gives you 7%. Even if you are a longer term investor in the FD, you pay interest every year (And the bank deducts 10% as TDS before you even see it).

The government has allowed certain entities to give you tax-free interest; if you are an investor for the long term, 10 to 15 years, in certain infrastructure companies. Two of them have already issued bonds (PFC and NHAI) and if you missed those, you can subscribe to the next two coming up from Jan 27: HUDCO and IRFC.

Issue IRFC HUDCO
Size Upto 6300 cr. Upto 4685 cr.
Interest Rate    
10 yr bond    
Retail * 8.15% 8.22%
Others 8.00% 8.10%
15 yr bond    
Retail * 8.30% 8.35%
Others 8.10% 8.20%
Minimum Rs. 10,000 Rs. 10,000
     
Opens 27-Jan-12 27-Jan-12
Closes 10-Feb-12 6-Feb-12

 

* Retail applications are for individuals, for under Rs. 5 lakh, and the higher interest rate is only for the first allotment. Any sale of the security will drop the interest down to the “Others” level.

The bonds will list on the NSE and BSE, and if you can’t get in now, you can buy them off the exchange. (PFC and NHAI bonds will list soon) and the interest will still be tax free. However, in the above two issues, the “coupon” rate paid on the bond will drop, for retail investors.

Since the bond interest is tax free, this is equivalent to a high interest yielding fixed deposit based on the tax bracket you are in. That is, if you had an interest rate of 30% at your highest tax bracket, a coupon rate of 8.35% means an equivalent FD of 12.08%.

But this is a silly comparison. There is no liquidity – of course the bonds are listed but there’s no guarantee that there will be someone willing to buy. Even if there is, the price someone may be willing to pay could be far lesser – in terms of effective yield – than the price you want (An FD can always be returned early with no loss of principal and perhaps a little penalty on the interest) This is like a 15 year FD.

You needn’t invest in an FD to get a similar return, of course. If you’re thinking of exiting in a few years, you may be better off with a longer term FMP, where the post tax returns are around 9-10% nowadays. These mutual funds lock you in similarly, and are listed, but the interest is not taxed till maturity; they tend to yield between 9-11% (this is the rate for long term commercial bonds nowadays) and the fact that you get an indexation benefit will make much of the gain non-taxable.

(A 9% return with inflation at 8% means only the excess 1% is chargeable to tax – even at the highest bracket you’ll make 8.70%)

The comparison, for those who are thinking of this bond as a 1 to 5 year investment, is better off with a similar tenure FMP, or if you choose to be a little creative, with a bond fund.

I strongly believe that we have overcomplicated our options. Thinking in terms of “you can’t compare this with a gilt fund” etc. are simply skirting the issue. People like to think in terms of “debt” versus “equity”, and then long versus short term. FD is debt, as is a bond fund, as is a HUDCO bond. If interest rates fall, a bond fund and the HUDCO bond will increase in market price, but nothing changes with the FD. If you are in for more than five years, and believe that interest rates will fall to below current levels, the HUDCO or IRFC bond is a good idea.

If you’re in for less than five years, consider a longer term FMP or a bond fund instead.

If you’re retired, these bonds are fabulous, because they give you cash flow on which you need to pay no taxes. And for fifteen years!

And finally if you’re a short term investor with the idea that you’ll speculate on these bonds, the trade will clear itself when the PFC/NHAI bonds list either Friday or Monday. Wait to see if there’s a listing gain available.

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  • Vijay says:

    Hey Deepak,
    DTC will erase the low tax ability of FMPs. IRFC bonds look very attractive for a tax payer in tax bracket. Also, with more and more bonds/NCDs coming for retail investors, these may become a lot more liquid in say 5 years from now. The interest rates may also fall to say around 6-7% in a few years. At that time, this will yield 18% annual returns from the present price! What say?

  • divay says:

    thanks for your insightful article , it has cleared my confusion in this regard .
    can you throw light on short term debt instruments for retail investor , my area of concern is T-bills , you article on( Retail debt market )in India would be highly appreciable.

  • User99 says:

    Seriously? No liquidity? Did yiu check the stats for past large bond/NCD issues like SBI N1-N6, Shriram Transport, even older smaller ones like Tata Cap? The bond, NCD market is already large enough for retail investors. Some more due diligence please? ( PS: I’d left an earlier comment too not sure if it went through)

    • Oh, there is hardly much liquidity – I have been trying to get a decent size of these bonds for days now. SBI’s N5 is reasonably liquid, Tatacap’s bonds is as well, but most of the others are very thinly traded. I’ve got a little tool which goes in and finds liquidity and alerts me and I compromise on the yield because I can’t get a hold of the bonds 🙂 a bid-ask of 10810 and 10940 with a depth of 2 bonds is not liquid at all.
      ALso, I agree that the market’s getting better now! I need to do some kind of tool for this.
      (btw, what earlier comment?)

  • Sanjay says:

    Hi Deepak,
    I want to invest in debt terms for long term but I might need it in between. (For example, I am planning to buy a car and at last moment I decide to increase my budget more by 1 lac) Which fund would make more sense? dynamic bond fund?
    Also, in one of earlier posts you had asked readers to go for ultra short term funds. That suggestion was for parking one’s emergency fund. What suggestion would you give if I don’t want money at short notice but I may need it before the investment instrument matures. It basically rules out FMP.
    I have come across advertisement of birla sun life dynamic bond fund and SBI dynamic bond fund. Which one would you suggest?

  • sriram says:

    >>you may be better off with a longer term FMP, where the post tax returns are around 9-10% nowadays
    could you please name a couple of such FMPs?
    thanks

  • Vinay Shah says:

    Hi Deepak,
    What does cumulative option in this types of bond mean ?
    The interest rate published, is it simple or compound interest for cumulative option ? If it is compound interest, then it seems that one will lose quite a bit compared to non-cumulative, isn’t it ? I will appreciate if you can throw some light on non-cumulative and cumulative option with an example.
    Regards,
    Vinay

  • RAKESH KUMAR JAIN says:

    I am interested to buy Bonds issued in 2012. Kindly suggest how to do it.