Tax Free Bonds – A better investment option
Please refer my earlier mail, informing you the launch of NHAI's tax free bond and I recommend subscribing this bond for those who are falling in the highest tax bracket to maximize the return in their investments in fixed income securities. As I said in my mail, this bond has been sold like hot cake and it is given to understand that this bond over subscribed to the tune of more than Rs. 20,000 crore. So tomorrow (31-12-2011) may be the last chance for retail investors to subscribe for this bond. But there is no guarantee that you will get the allotment.
If you missed the chance to subscribe for NHAI's bond, don't worry, Power Finance Company (PFC) is opening its similar type of tax free bond issue on 31-Dec-2011. Power Finance Corporation Ltd. (PFC), a Government of India undertaking with status of navratna PSU is launching Tax Free bonds, as per reports, from December 31, 2011 with coupon rates of 8.20% under 10 years plan and 8.30% under 15 years plan, for the value of Rs 1000 Crore with option to retain oversubscription upto the Shelf Limit of Rs 4033.13 Crore with face value of bonds of Rs 1000/- each at par value. The minimum investment will, however, be lower at Rs 10,000, as against NHAI's Rs 50,000.
In case you wish to subscribe for this issue, please ensure to submit your application on 31st-December itself otherwise again you will miss the chance to subscribe for a tax free bond with good post tax return with 100% government guarantee.
Effective Yields in NHAI & PFC Bonds for the investors in different tax brackets
| Tax Rates | 10 Years | 15 Years |
| Interest rates | 8.20% | 8.30% |
| 10.30% | 9.14% | 9.25% |
| 20.60% | 10.33% | 10.45% |
| 30.90% | 11.87% | 12.01% |
Highlights of the Bond Issue
| PUBLIC ISSUE OF TAX FREE BONDS |
| HIGHLIGHTS OF THE BOND ISSUE |
| Issuer | Power Finance Corporation Ltd. ("PFC"/ "Company"/ "Corporation") |
| Issue Opening Date | 31/12/2011 |
| Issue Closing Date | 16/01/2012 |
| | The subscription list for the Issue shall remain open for subscription at the commencement of banking hours and close at the close of banking hours, with an option for early closure (subject to the Issue being open for a minimum of 3 days) or extension by such period, upto a period of 30 days from the date of opening of the Issue, as may be decided by the Board of Directors/ Committee of PFC. In the event of such early closure of the subscription list of the Issue, our company shall ensure that public notice of such early closure is published on or before the day of such early date of closure through advertisement(s) in a leading national daily newspaper. |
| Instrument | Tax Free Secured Redeemable Non Convertible Bonds in the nature of Debentures |
| Issue Size | Rs. 1,000 crores with an option to retain an oversubscription upto the Shelf Limit of Rs. 4033.13 crores |
| Tax Benefits | 1. The income by way of interest on these Bonds shall not form part of total income as per provisions under section 10 (15) (iv) (h) of I.T. Act, 1961; |
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| 2. There shall be no deduction of tax at source from the interest, which accrues to the bondholders in these bonds irrespective of the amount of the interest or the status of the investors; |
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| 3. As per section 112 of the IT Act, capital gains arising on the transfer of long term capital assets being listed securities are subject to tax at the rate of 20% of capital gains calculated after reducing indexed cost of acquisition or 10% of capital gains without indexation of the cost of acquisition; |
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| 4. Wealth Tax is not levied on investment in Bond under section 2(ea) of the Wealth-tax Act, 1957. |
| Instrument Form | At the option of investors, in dematerialized form and in physical form |
| Trading | Only in dematerialized form |
| Security | Charge on the book debts of the Issuer and/or identified immovable property by a first/ pari passu charge, as may be agreed between the Issuer and the Debenture Trustee, pursuant to the terms of the Debenture Trust Deed |
| Credit Rating | "CRISIL AAA/Stable" by CRISIL and "[ICRA] AAA" by ICRA |
| Face Value | Rs. 1,000/- per Bond |
| Issue Price | At par i.e. Rs. 1,000/- per Bond |
| Minimum Application | 10 Bonds (Rs. 10,000/-) and in multiples of 5 Bonds (Rs. 5,000/-) thereafter |
| Tranche/ Series | Tranche-I Series-I | Tranche-I Series-II |
| Tenor | 10 Years | 15 Years |
| Put & Call Option | None | None |
| Maturity/ Redemption | At par on the expiry of 10th Year from the Deemed Date of Allotment | At par on the expiry of 15th Year from the Deemed Date of Allotment |
| Coupon Rate | 8.20% p.a. | 8.30% p.a. |
| Interest Payment | Annual | Annual |
| Interest Payment Dates | Every year on October 15, and on respective maturity |
| Listing | Proposed on BSE Ltd. ("BSE") |
| Trustee | GDA Trustee & Consultancy Ltd. |
| Deemed Date of Allotment | The date on which the Directors of the Company or any committee thereof approves the Allotment of the Bonds. All benefits relating to the Bonds including interest on Bonds shall be available to the investors from the Deemed Date of Allotment. The actual allotment of Bonds may take place on a date other than the Deemed Date of Allotment |
| Record Date | 15 days prior to the due date for payment of interest or repayment of principal amount on maturity. In case of redemption of Bonds, the trading in the Bonds shall remain suspended between the record date and the date of redemption |
| Issue Objects | The proceeds of the Issue shall be utilised towards lending purposes, debt servicing and working capital requirements of the Issuer |
| Interest on Application Money | At the respective coupon rate (subject to deduction of income tax under the provisions of IT Act, 1961, as applicable), to the applicants to whom Bonds are allotted pursuant to the Issue from the date of realization of the cheque(s)/ demand draft(s) or 3 (three) days from the date of banking of the application (being the date of submission of each application as duly acknowledged by the Bankers to the Issue) whichever is later upto one day prior to the Deemed Date of Allotment. |
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| At the rate of 5% p.a. (subject to deduction of income tax under the provisions of the IT Act, 1961, as applicable) to the applicants to whom application monies are liable to be refunded the along with refund amount from the date of realization of the cheque(s)/ demand draft(s) or 3 (three) days from the date of receipt of the application (being the date of presentation of each application as acknowledged by the Bankers to the Issue) whichever is later upto one day prior to the Deemed Date of Allotment. |
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| PFC shall not be liable to pay any interest on monies liable to be refunded in case of (a) invalid applications or applications liable to be rejected, and/or (b) applications which are withdrawn by the applicant. |
| Nature of Indebtedness and Ranking | The claims of the Bondholders shall rank pari passu with other secured creditors having a charge over the on the book debts of the company and/or identified immovable property as may be agreed between the Company and the Debenture Trustee, pursuant to the terms of the Debenture Trust Deed and such claims shall be superior to the claims of any unsecured creditors |
| Lead Managers to the Issue | SBI Capital Markets Ltd., A.K. Capital Services Ltd. and RR Investors Capital Services (P) Ltd. |
| Bankers to the Issue | (i) State Bank of India, (ii) HDFC Bank Ltd., (iii) IDBI Bank Ltd., (iv) ICICI Bank Ltd. (v) Kotak Mahindra Bank Ltd., (vi) Axis Bank Ltd., (vii) Dhanlaxmi Bank Ltd., and (viii) IndusInd Bank Ltd. |
| Base Issue Size | Rs. 1,000 crore |
| Overall Issue Size | The aggregate value of Bonds decided to be allotted in the Issue (over and above the Base Issue Size, in case if PFC decides to retain any oversubscription in the Issue) |
| Reservation for Categories | On first-come-first-serve basis |
What Tax Free means?
- The income by way of interest on these Bonds is fully exempt from Income Tax and shall not form part of Total Income.
- There will be no deduction of tax at source (TDS) from the interest, which accrues to the bondholders in these bonds irrespective of the amount of interest or the status of the investors.
- Wealth tax will not be applicable on these bonds.
Note: If you redeem these bonds through stock exchange before maturity – there can be capital gain tax or capital loss depending on your sale price. There is a chance to earn capital gain on these bonds, if you sell through stock exchanges before the maturity date.
Most of the people are confused these tax free bond issue with other long term infrastructure bond issues like IDFC, L&T etc. This is not a tax savings bond eligible to claim deduction under section 80CCF of the Income Tax. If you investment in long term infrastructure bond you claim a deduction upto Rs. 20,000.00 u/s 80CCF. But the interest earned there is taxable like bank term deposits. In case of PFC and NHAI bonds, there is no tax deduction on the principal amount invested, instead the interest earned will be fully exempted from income tax u/s 10(15)(iv)(h) of Income Tax Act. Please note that the sum invested in these bonds is not eligible for any deduction under section 80C, 80CCF or 54EC. The interest on these bonds is tax free. Thus no income tax would be required to be paid, nor will it be subject to TDS. However, capital gains on these bonds are taxable like normal corporate bonds. If the bonds are sold within one year of the date of purchase, the short term capital gains arising would be subject to tax at slab rates. For sale after a holding period of one year, the long term capital gains will be taxable at 10% without any indexation benefit.
If we compare this bond with PFF, though an 8.6 per cent annual tax-free return on PPF with or without the tax deduction sounds good for this financial year. Since the interest rates on all small savings schemes are now linked to G-Sec, there are all possibilities that, the interest rates may start sliding now onwards. Therefore, you may not get 8.6% interest next year. So better lock in your investment for a long period of 10 years or a very long period of 15 years with a guaranteed return with tax benefits. When compared to these bonds PPF is quite illiquid. It is expected to list this bond at a premium, one can cash on the gains being the price difference between the cost and market price. This is applicable for speculators or short term the investors, log term investors can hold this bonds up to maturity. Once the interest rates cycle starts reverses, the demand for this bond will naturally go up similarly the traded prices of this bond also go up. There is an inverse relationship between bond prices and interest rates. Please keep in mind that, if the bonds are sold within a year, then the gains will be added to your income and taxed. If held for more than a year before sale, the capital gains will be taxed at 10 per cent without indexation or 20 per cent with indexation.
Disclaimer: This article is just for the general information of the readers, in case you need more information for contact your investment consultant or refer bond prospectus
Best Regards
Prakash Nair
