Most of the instruments in India, particularly the traditional fixed deposits attract tax in India. What this means is that if you invest in the same, you have to add the interest income to the total income for the purpose of paying tax.
However, there are certain fixed investments in India whose interest income is tax free and on which you do not have to pay income tax. Here are a few such instruments that offer tax free interest income in India.
1) Tax Free Bonds
Government owned companies come out with tax free bonds from time to time. Last year there were no tax free bonds, but, this year the government has announced a host of companies that can raise money through tax free bonds. This is normally announced in the Union Budget. Among these include the likes of National Highways Authority of India which plans to raise Rs 24,000 crores, Indian Railways Finance Corporation to raise Rs 6000 and HUDCO to raise Rs 5000 crores.
Tax free bond are completely exempt from income tax under section 10. What this means is that if you place money in these tax free bonds, the interest earned is not added to total income while computing your tax liability.
These bonds are generally of 10, 15 and 20 years duration. However, they are liquid in the sense they are traded on the stock exchanges, though the volume is not very great.
Unit Linked Insurance Plan
Unit Linked Insurance Plan (ULIP), combines the benefit of insurance and investment. Part of the money is allocated for insurance, while the rest is invested in stock markets or debt instruments depending on the need of the investor.
The interest earned or the profits made from ULIPs are not taxed. The other benefit of ULIPs is that you also get tax benefits under Sec 80C of the Income Tax Act. So, if you invest a sum up to Rs 1.5 lakhs, the same can be deducted from your total income.
ULIPs can sometimes be a little risky, if one opts for part of the investment to be done in stock market related instruments. However, the tax benefits under Sec 80D of the income tax act make it a worthy investment bet.
Learn more about the difference between ULIPs and PPF click here
The Public Provident Fund or PPF is another instrument that qualifies for tax rebate. The interest income earned from PPF is completely exempt from tax. Like ULIPs, the amount invested in PPF also qualifies for tax benefit under Sec 80C of the Income Tax Act. So, you can invest up to Rs 1.5 lakhs and save tax.
However, there are certain drawbacks of the PPF like the lock-in period of 7 years. On the other hand ULIPs have a lock-in period of only 5 years, while tax free bonds do not have a lock-in period. However, if you sold your tax free bonds, you would not receive any interest payment, which defeats the purpose of investing in tax free bonds.
It all depends on your needs when choosing the type of instrument. If you are looking at an instrument that gives some insurance protection for your family then the ideal bet would be the ULIP. On the other hand if you do want to avail of Sec 80C tax benefits, then the tax free bonds could also be an attractive proposition.