Various Type of Bonds

Some investment opportunities carry a significant amount of risk but offer higher returns as well, such as equity market investments. There are some investments that offer you lower returns but have minimal risk attached such as bank deposits. Getting the right balance of various investments will balance your portfolio. One of the most popular investment options is Bonds. Let’s understand more about bonds and how the Indian bond market works.

What are Bonds?

In India, bonds are issued by the Government as well as the private-sector entities, to raise money for a specific purpose. They are essentially interest-bearing debt certificates. Bonds are like a loan which carries an interest rate and must be repaid on a specified date. Government and large corporations issue bonds when their funding requirement cannot be met from any other source. Bonds have a specified maturity period upon completion of which the borrower (Government or Private Corporation) will return the money to the lender. The money will be returned along with the interest, specified at the time of issue, and specified intervals.

Type of Bonds?

54EC BONDS – CAPITAL GAIN BONDS ISSUED UNDER SECTION 54EC:

Long-term capital gain is the gain that is derived out of a sale of an asset that has been held for more than a year. You can invest the gain in certain specified bonds to claim tax exemption within 6 months of the date of sale of the asset. Save tax on long-term capital gains by investing in 54EC bonds such as REC capital gain bonds, NHAI capital gain bonds respectively. Budget 2018 has proposed to amend the 54EC section of the Income Tax Act wherein capital gains arising only from the sale of assets such as land or building or both will be considered for tax exemption. It has also proposed to increase the lock-in period to 5 years from 3 years. This amendment will take effect from 1st April 2019.

Key Features of Capital Gain Bonds specified under Section 54EC:

  1. Non transferable and non negotiable bonds
  2. No TDS but interest earned is taxed
  3. AAA credit rating by ICRA, CRISIL and India Ratings and Research Private Limited
  4. Maximum investment is Rs. 50 lakh
  5. Maximum of 500 bonds can be bought at Rs. 10000 per bond
  6. Annual interest rate at 5.75%
  7. Tenure of the bond is 5 years
  8. Available in Physical as well as demat form

The Analysis:

According to section 54EC of I.T., any person (individuals, HUFs, partnership firms, companies etc.) can avail exemption in respect of long-term capital gains (arising from the sale of a long-term capital asset other than equity shares and securities), if the capital gain is invested in Capital Gain bonds. The exemption will be the amount of capital gain or the amount of investment made, whichever is less.

The interest rate offered on these bonds is 5.75% per annum. The exemption is subject to:

  • The investment is made within a period of 6 months from the date of transfer of the asset
  • Lock-in period to 5 years from 3 years. This amendment will take effect from 1stApril 2019
  • Bonds sold, transferred or converted into money or any loan or advance taken on the security of such bond within a period of 3 years from the date of acquisition, the capital gains earlier exempt are taxable in the year of sale or transfer of the bonds
  • Maximum investment limit of up to Rs. 50 Lakhs in a Financial Year per individual.
  • If the amount invested in bonds is less than the capital gains realized, only proportionate capital gains would be exempt from tax.

Those who wish to save taxes on LTCG can invest the amount in the capital gains bonds within six months from the date of arising profit. By investing in 54 ec Capital gain bond one can save up to Rs 50 Lakh in a single financial year. These instruments are not only capital protected instruments, but they also provide a steady stream of income to you.

54EC BONDS FAQs:

Q: Which bonds are eligible under the Section 54 EC?
A:
REC (Rural Electrification Corporation) and NHAI (National Highways Authority of India) are the bonds eligible under Section 54 EC.
Q: What is the maximum investment limit for the Section 54 EC- Capital Gain Bonds?
A:
Rs. 50 lakh is the maximum amount that can be invested in these bonds.
Q: What is the rate of interest for these bonds?
A:
5.75% is the interest rate offered by these bonds.
Q: What is the lock-in period for investment?
A:
The lock-in period will be 5 years with effect from April 1, 2019.

TAX FREE BONDS:

Tax-free bonds are types of goods or financial products, which the government enterprises issue. One example of these bonds is the municipal bonds. They offer a fixed interest rate and hence are a low-risk investment avenue. As the name suggests, its most attractive feature is its absolute tax exemption as per Section 10 of the Income Tax Act of India, 1961. Tax-free bonds generally have a long-term maturity of ten years or more. Government invests the money collected from these bonds in infrastructure and housing.

What are the features of Tax-Free Bonds?

  • Tax-exemption

In the case of tax-free bonds, the income you earn in the form of interest is entirely free from income tax. There is no tax deducted at source (TDS) applicable to these bonds either. However, it is advised to declare your interest as income as tax-free bonds do not imply that you can claim the investment amount for the tax deduction. Tax-free bonds, when compared to the bank FDs, offer great benefits to investors who fall in the high tax bracket.

  • Risk factors

Chances of defaulting on interest payment are very low as these schemes are from the government itself. It also offers capital protection and a fixed annual income. Hence, it is quite safe.

  • Liquidity

You cannot liquidate tax-free bonds as quickly as, say, debt funds. Since government bonds are long-term investments and have more extended lock-in periods, liquidation of the bonds may not be that easy. Hence, tax-free bonds do not act as an emergency fund.

  • Lock-in tenure

Tax-free bonds have higher lock-in-period that range from 10 to 20 years. You cannot withdraw your money before the maturity date. Therefore, please make sure that you will not need this money shortly before investing.

  • Issuance & transaction

Tax-free bonds are issued through a Demat account or in physical mode. They mainly trade in stock markets. Hence, the interest you earn on these bonds is tax-free. However, the capital gain from selling these bonds in stock markets is taxable.

  • Returns

The returns you make on these bonds are primarily dependent on the purchase price. This is because they are traded in low volumes with a limited number of interested buyers or sellers.

  • Interest

The rate of interest offered on tax-free bonds generally ranges from 5.50% – 6.50%, which is fairly attractive when considering the tax exemption on these bonds. The bondholder receives the interest annually. However, the rates are subject to fluctuations as they are related to the current rate of government securities.

What are the commonly found Tax-Free Bonds?

Many public undertakings issue tax-free bonds. National Highway Authority of India, NTPC Limited and Indian Railways, Rural Electrification Corporation are some of the widely known ones. Housing and Urban Development Corporation, Indian Renewable Energy Development Agency, Rural Electrification Limited and Power Finance Corporation are other examples. Therefore, you must always check the authenticity before buying.

NCD (NON CONVERTIBLE DEBENTURES):

Non-convertible debentures (NCDs) are a financial instrument that is used by companies to raise long-term capital. This is done through a public issue.

NCDs are a debt instrument with a fixed tenure and people who invest in these receive regular interest at a certain rate.

Why is it called non-convertible?

Some debentures can be converted into shares after a certain point in time. This is done at the discretion of the owner. However, this is not possible in the case of NCDs. That’s why they are known as non-convertible.

Even though NCDs cannot be converted into shares, they offer other benefits.

  • High interest rates

The rate of return on NCDs is around 11-12%. This is high compared to most investment options. For example, fixed deposits (FDs) are another popular avenue where people put their money for regular returns. However, the returns are much lower.

There are various interest payout options including monthly, quarterly, semi-annually and annual payments. The maturity period for an NCD can be anywhere between 90 days to 20 years. This gives you the flexibility to choose between short and long tenures based on your investment goals.

  • Liquidity

Since they are listed on the stock exchanges, NCDs are easy to withdraw. Redeeming your NCD investment may be a little tougher than selling regular stocks, but they are more liquid than bank fixed deposits.

Important terms you should know:

  1. Secured and unsecured NCDs

An NCD can either be secured or unsecured. A secured NCD is backed by the issuing company’s assets. This means that the company has to fulfil its debt obligation whatsoever. However, that’s not the case for unsecured NCDs. This makes secured NCDs safer since they have a lower default risk.

  • Ratings

If you seek to buy NCDs, it is very important to know the rating of the debenture before you buy it. Every company that seeks to raise money through an NCD is rated by agencies such as Fitch Ratings, CRISIL, ICRA and CARE. These rating agencies rate the company based on its ability to service its debt on time. So, a lower rating means a higher credit risk.

  • Tenure

A non convertible debenture is simply a debt instrument used by a company when it wishes to raise money from the public. The company issues a debt paper for a specific tenor. During this period, it pays a fixed rate of interest to the buyer. This could be on a monthly, quarterly or annual basis. At the end of the tenor, the money that is invested is returned back to the buyer.

  • Yield

Yield is a financial jargon used to describe the income return earned on a security over a specific period of time. In case of NCDs, the yield on redemption has been quite attractive for buyers. This is because they generally offer higher yields when compared to even corporate FDs.

Things to consider before investing in NCDs

  • Check company’s background

Make sure you research the company’s history before you invest. Check if the company has raised money in the past and has successfully repaid its debts. It is a good sign if the company has met its obligations. Else, you may want to avoid investing in the company.

  • Check company’s credit rating

The biggest draw for NCDs is the interest rate offered. However, that should not be the sole reason to invest. It is important that the high interest rate offered by the company is backed by good credit ratings. Study the credit ratings given to the company by different rating agencies such as CRISIL before you make your decision. A higher rating will suggest the company has the ability to repay its loans.

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