TAX-FREE BONDS

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Tax-free Bonds

Tax-free bonds are financial instruments issued by government-backed entities, such as government-owned companies or infrastructure development authorities, to raise funds for specific projects. The distinguishing feature of tax-free bonds is that the interest income earned by investors is exempt from income tax, making them an attractive investment option for individuals seeking tax-efficient returns.

Key Features Of Tax-free Bonds Include:

  • Interest Income Exemption: The interest income generated from tax-free bonds is exempt from income tax under Section 10(15)(iv)(h) of the Income Tax Act, 1961. This makes them a popular choice for investors in higher tax brackets looking for tax-free returns.

  • Issued by Government Entities: Tax-free bonds are typically issued by government entities, such as government-owned companies or infrastructure development authorities. These entities use the funds raised through the issuance of bonds for specific projects like infrastructure development, industrial expansion, or other capital expenditures.

  • Fixed Interest Rate: Tax-free bonds usually come with a fixed interest rate that remains constant throughout the tenure of the bond. The interest is paid periodically, often semi-annually or annually, to bondholders.

  • Long Tenure: Tax-free bonds generally have a longer maturity period, often ranging from 10 to 20 years. Investors should be prepared for a lock-in period until maturity.

  • Liquidity: While tax-free bonds have a fixed tenure, they are tradable on stock exchanges. Investors can sell the bonds in the secondary market before maturity if they need liquidity. However, market conditions and demand for the bonds will influence the selling price.

  • Credit Rating: Tax-free bonds are assigned credit ratings by credit rating agencies. These ratings reflect the issuer's creditworthiness and the safety of the investment. Higher-rated bonds are considered lower risk.

  • No TDS (Tax Deducted at Source): The interest income from tax-free bonds is not subject to Tax Deducted at Source (TDS), which means that investors receive the full interest amount without any tax deduction.

  • No Wealth Tax: Investments in tax-free bonds are exempt from wealth tax, providing an additional advantage.

  • Dematerialized Form: Tax-free bonds can be held in both physical and dematerialized (demat) form. Holding them in demat form provides convenience and ease of trading on stock exchanges.

It's important for investors to carefully consider their investment objectives, risk tolerance, and tax implications before investing in tax-free bonds. While they offer tax advantages, they also come with interest rate risk, as the fixed interest rate may not keep pace with inflation over the long term. Additionally, market conditions can impact the tradability and market price of these bonds.