What Is The Difference Between Tax-Free Bonds And Tax-Saving Bonds?

Tax Free bonds and tax saving bonds though misunderstood to be same are rather two different investment options suitable for different class of investors. And as the financial year is nearing its end in March, taxpayers at this time of the year may be hunting for investment avenues to claim tax benefits on them. If you too are scouting for similar options, you can consider tax savings bonds and tax free bonds depending upon your profile. Here we lists out the key differences between the two:

What Is The Difference Between Tax-Free Bonds And Tax-Saving Bonds?

Tax Savings bonds offer tax benefit under Sec 80CCF whereas in case of tax free bonds interest accrued is tax free: In the case of tax savings bonds, tax benefit is provided on the principal amount i.e. invested in these bonds as part of Section 80CCF of the Income tax act. As per which, investment in tax savings bonds allow tax deduction of up to Rs. 20000. So, in a particular financial year, an individual taxpayer can reduce his or her total taxable income by Rs. 20,000. Notably, the deduction allowed as part of Section 80CCF is over and above the tax relief offered as part of Section 80C that extends tax benefit of up to Rs. 1.5 lakh.

For tax-free bonds which provides annual coupon to investor, the interest income made on tax free bonds is completely tax free that is there arises no tax implication on the interest realized on these tax free bonds as per Section 10 of the Income Tax Act, 1961. But unlike tax free bonds, for tax savings bonds interest is taxable.

Further, in case of tax free bonds, if they are redeemed in the secondary market and investor makes any capital gains then the same qualify for short or long term capital gains tax which is depending on the holding period. If the holding period is less than one year then tax at the rate of individual's slab rate applies. And if the holding period is of over a year then LTCG tax @ 10% without indexation becomes applicable.

Lock in period: Both come with a lock-in period but in the case of tax free bonds they offer thin liquidity as they trade on the exchanges and hence on any price increase or otherwise investors can redeem their investments in them.

Suitable for whom: Tax savings bonds being mid-to-long term investment option are suitable for investors seeking long term returns. Also, the returns offered are comparatively low as they indeed carry low risk.

On the other hands, tax free bonds that provide tax-free interest are suitable for conservative retiree or senior citizens looking for regular income investor class who falls in the highest tax slab of 30%. Other investor categories who can consider investment in tax free bonds include HUFs, HNIs,qualified institutional investors and cooperative banks.

Higher return in case of tax free bonds: Tax free bonds unlike tax savings bonds offer a better return rate and investors can invest up to Rs. 5 lakh in tax free bonds. Also, as these are primarily issued by government backed entities, these are highly safe and carry low default risk.

And as is the case now, investors in tax free bonds can expect better returns as when interest rates in the economy head southwards, these bonds offer capital appreciation to tax free bondholders.

Further, interest rate on tax-free bonds are based on current rates on G-securities. And currently with coupon offering of 5.8% these are attractive in comparison to bank FDs on a post tax basis.

GoodReturns.in