What Are Tax Free Bonds? Should You Invest In Them?

A few years ago, there were bonds that were issued by government companies like Rural Electrification Corporation, Indian Railways Finance Corporation, Housing an Urban Development Company etc.

The interest paid on these bonds were tax free in the hands of investors. There are very few instruments where the interest is tax free including the likes of PPF and ULIPS. In most cases, the interest earned is taxable in the hands of investors.

Where to buy these tax free bonds?

The tax free bonds are readily traded on the exchanges. So, you can buy these bonds through the BSE and NSE. All of the bonds offer an interest rate that is paid annually. It is important to note that the volumes on these bonds are not great. So, if you want to buy say a quantity of 5,000 bonds, it maybe difficult and you may not get the right price.

Should you buy these tax free bonds?

This really depends on the price of the bonds. The higher you buy the bonds, lower will be your returns and vice versa. Let us explain with an example. Say an investor bought the original HUDCO Bonds for Rs 1,000, with an interest rate of 8.15 per cent. For an investment of 10 bonds, which totals Rs 10,000, he receives an interest rate of Rs 815 every year, which is completely tax free.

Now, if you are buying the bonds from the stock exchanges, the bond prices are going to be higher, as interest rates are fallen. So, if you buy the same bonds at a price of Rs 1,100, you get only 9 bonds, which means your returns would be just 7.33 per cent. So clearly, you need to buy at the best price to get decent returns on the bonds.

So, in short, buying or selling these bonds really depends on the price of the bonds. Currently, even bank interest rates have fallen sharply to levels of just 5 to 5.5 per cent. In fact, since interest rates have fallen a great deal bond prices could definitely be higher.

Conclusion

All an all, tax free bonds are good provided you get them at the right price. If the prices are not right, your returns could be poor. Do not buy large quantities as selling could than be difficult.

About the author

Sunil Fernandes has spent 26 years covering business and finance in India and abroad. Sunil has worked with frontline daily newspapers including Hindustan Times, Deccan Herald and Gulf Times. He has also worked with investment magazines like Dalal Street Investment Journal and Oman Economic Review. His forte remains stocks, commodities, debt, mutual funds and tax planning. Sunil is currently Managing Editor for Goodreturns.in