Tax Free Bonds Notification – FY 2013-14

by Shiv Kukreja on August 16, 2013

in Fixed Deposits

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

Amid volatile stock markets, rising interest rates and weakening economic growth, the investors are running out of patience now, even with their so-called “safe debt investments” in the form of debt mutual funds, including the ‘safest’ liquid funds. They now want only those investments in their portfolio which are offering fixed guaranteed returns, even if the returns are lower than debt mutual funds.

One such investment, which has been really attractive for them for the past few years, is Tax-Free bonds. The Central Board of Direct Taxes (CBDT) has notified the rules on issuance of tax-free bonds for the current financial year – 2013-14. In the budget this year, the Finance Minister P Chidambaram proposed tax free bonds to the tune of Rs. 50,000 crore, the size of which, as per the notification, has been cut to Rs. 48,000 crore.

The notification for the tax free bonds for the current financial year got issued by the CBDT on Thursday, August 8th. Here is the Taxmann link to the notification.

There are a few changes in the rules for this year’s bond issuances as compared to the last year and I will list out all those changes later in the post. Let us first check out the features and other details of the notification.

Thirteen companies in the infrastructure development or infrastructure finance space have been authorised to issue tax-free bonds this year, namely IIFCL, IRFC, NHAI, REC, PFC, HUDCO, NHB, NTPC, NHPC, IREDA, AAI, Ennore Port and Cochin Ship Yard. These bonds will be issued for 10 years, 15 years or 20 years. It is not clear though which entities will be allowed to issue these bonds for 20 years. Last year, only IIFCL was allowed to issue these bonds for 20 years.

Here is the list of all these entities along with the stated limits of amount to be raised through these tax free bonds:

The investors have been classified in the following four categories:-

1) Retail Individual Investors (RIIs)

2) Qualified Institutional Buyers (QIBs)

3) Corporates

4) High Net Worth Individuals (HNIs)

The definition of a Retail Individual Investor has been left unchanged this year. As per the notification, Retail Individual Investors would mean those individual investors, Hindu Undivided Families or HUFs (through Karta), and Non Resident Indians (NRIs), applying for up to Rs. 10 lakhs in each issue. Individual investors investing more than Rs. 10 lakhs will be classified as High Net Worth Individuals (HNIs).

The companies are allowed to issue these bonds either through public issues or private placements. As per the notification, at least 70% of the authorised amount of bonds issued by each entity will have to be raised through public issues. For instance, if IIFCL raises Rs. 10,000 crore from these bonds this year, then Rs. 7,000 crore out of it will have to be raised through public issues only and the rest Rs. 3,000 crore, IIFCL can raise through private placements.

Like last year, there would be an applicable ceiling on the coupon rates offered by the issuer companies, based on the reference Government security (G-sec) rate. The ceiling coupon rate for a AAA rated issuer company will be 55 basis points (or 0.55%) less than the reference G-sec rate in case of Retail Individual Investors and 80 basis points (or 0.80%) less than the reference G-sec rate in case of other investors, like Qualified Institutional Buyers (QIBs), Corporate and High Net Worth Individuals (HNIs).

In case of issuer companies having credit rating of AA+, the ceiling coupon rate will be 45 basis points less than the reference G-sec rate in case of Retail Individual Investors and 70 basis points less than the reference G-sec rate in case of other investors.

In case of issuer companies having credit rating of AA or AA-, the ceiling coupon rate will be 35 basis points less than the reference G-sec rate in case of Retail Individual Investors and 60 basis points less than the reference G-sec rate in case of other investors.

In case the issuer company decides to make the interest payments semi-annually, it will have to lower the coupon rate by 15 basis points or 0.15%.

As per the notification – “The reference G-sec rate would be the average of the base yield of G-sec for equivalent maturity reported by Fixed Income Money Market and Derivative Association of India (FIMMDA) on a daily basis (working day) prevailing for two weeks ending on Friday immediately preceding the filing of the final prospectus with the Exchange or Registrar of Companies (ROC) in case of public issue and the issue opening date in case of private placement.”

There are quite a lot of things which would make the retail investors happy this year.

1. The coupon rates to be offered this year will be higher than the last year and there are two reasons for that. One, the yields on government bonds have risen this year as compared to the last year when these bonds got issued. Second, the cap on the ceiling coupon rate will get higher as the deductions from the reference rates have been lowered to 55-80 basis points as compared to 65-115 basis points of last year.

The demand from the QIBs, corporates and HNIs was very muted last year as the cut from the reference rates was quite high at 115 basis points (or 1.15%). This year it has been lowered to 80 basis points (or 0.80%). I think their demand for these bonds would be higher this year and it would also help increase liquidity in the secondary markets.

2. One thing which is very important to notice here is that the difference between the rates offered to the retail individual investors and the other categories of investors has been cut down to 25 basis points (or 0.25%) only, as compared to last year’s 50 basis points (or 0.50%). I think this factor also would attract higher participation from the other categories of investors and thus increase liquidity in the secondary markets.

3. As per the notification “The higher rate of interest, applicable to RIIs, shall not be available in case the bonds are transferred by RIIs to non retail investors”. Till last year, only the first allottees were eligible for a higher rate of interest and the subsequent buyers from the secondary markets were supposed to get a lower rate of interest. The language of the notification suggests me that the interest rates earned by the retail individual investors (RIIs) this year would remain higher even if they buy it from the secondary markets subsequent to the offer period. This factor will have greater participation from the retail investors in the secondary markets and thereby result in higher liquidity.

4. Like last year, in case of public issues, 40% of each such issue will be reserved for the retail investors category. So, there is no cut in the reserved portion of the retail investors.

As the 10-year benchmark G-sec yield touched 8.40% today, it would be good for these companies to come out with such issues soon so that they are able to attract sufficient participation from the investors. But, at a time when the economy is in a really bad shape and companies are reluctant to do any kind of capex, do these companies really require these funds for infrastructure development or for further lending?

Some of these companies, like NHAI, are already sitting on a huge cash in their books and are unable to properly utilise this money and some of these companies, like PFC and REC, are wasting these funds in debt restructuring of state electricity boards (SEBs). I don’t know whether it would be wise to invest in these bonds from value-addition point of view, but from returns point, I think it would be a good opportunity for the investors in the 30% and 20% tax brackets.

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{ 28 comments… read them below or add one }

G August 17, 2013 at 9:34 am

Hi..

I have a question.. if you are living abroad, how to get dividend get automatically deposited in your bank account rather than company sending checks abroad.. in Indian rupee

Reply

Shiv Kukreja August 18, 2013 at 7:46 pm

Hi G,
ECS is the facility that makes dividends/interests get automatically credited to your bank account wherever you live. You need to contact the Registrar and get your investment registered for the ECS facility.

Reply

G August 21, 2013 at 1:31 am

Many thanks Shiv.. really appreciate it..
my questions is who is the Registrar?

is it the bank where PIS account is or broker or NSEL?

Reply

Shiv Kukreja August 23, 2013 at 8:55 pm

Hi G,
I have no idea which product/issue you are talking about, so I’m not in a position to tell you about the Registrar.

Reply

Meet August 21, 2013 at 8:51 pm

Hi Shiv,

To understand, as the 10Y G Sec rate is around 8.4%, the yield is expected to be around 8% for these bonds, is my understanding correct ?

For people like me within 10% tax bracket, does it make more sense to invest in FMPs instead, where I get greater than 10% interest with benefit of indexation ?

Also, can you please post an article regarding how to select FMPs, what factors to consider etc..

Many thanks.

Thanks.

Reply

Shiv Kukreja August 23, 2013 at 9:09 pm

Hi Meet,
Coupon Rate will be 55 bps (or 0.55%) lower than the average yield of 10-year G-secs. So, if it is 8.4% average, then the coupon rate should be 7.85% for 10 year tenor. It would be 8% if the average yield comes out to be 8.55%.

FMPs have become quite attractive now, but I think the returns should be around 9% (even after indexation) and not 10% as you are saying. I think FMPs and Short-Term funds should give similar returns in the next one year and the tax treatment is the same for both. So, if you require liquidity, short-term funds are better and if you require zero volatility, then FMPs are better.

I’ll try to do a post on FMPs. Thanks!

Reply

Vivek August 27, 2013 at 9:05 pm

Shiv:
REC came out today with a bumper 8.71% for retail / 15 years. Sounds too good to be true. Lock kiya jaye ?

Reply

Shiv Kukreja August 28, 2013 at 10:20 am

Hi Vivek,
The interest rates look very attractive to me. It is one of the best long-term investment option at this point in time. But, at the same time, the macroeconomic picture is getting worse every passing day, its getting scary now. Ya, its better to stay invested in these kind of high fixed income products.

Reply

Varun August 28, 2013 at 6:09 pm

A side question: if someone invest more than 2 lakhs in any one bond, does it increase chance of coming under tax scrutiny? Of course, it is hard earned money, so no issues otherwise; but still. Any clues on this?

Reply

Shiv Kukreja August 29, 2013 at 8:56 pm

Hi Varun,

Rs. 2 lakhs and Rs. 5 lakhs were the threshold limits for Mutual Funds and Bonds/Debentures respectively, for falling under AIR transactions (or tax scrutiny) till sometime back. I think it has been raised to Rs. 10 lakhs for Mutual Funds, Bonds/Debentures and Shares combined.

Source: http://www.indianexpress.com/news/threshold-norms-for-tax-scrutiny-of-highvalue-transactions-raised/1123020/

Reply

Varun August 29, 2013 at 11:06 pm

Thanks Shiv.
Slight confusion here. Isn’t that the (earlier) limit of Rs. 2 lakhs & 5 lakhs for Mutual funds or Bonds was on ‘single’ transaction rather than cumulative investment on mutual funds or bonds respectively in a financial year? (refer to http://www.dnaindia.com/money/1546714/comment-beware-your-investments-are-reported)
Not sure if this new limit of 10 lakhs is cumulative or as a single transaction in a single company. But I strongly believe these limits should be on single transaction basis it is the responsibility of the company to report it rather than the Demat firm. It also match with the new Retail investor limit of 10 lakhs.

Reply

Shiv Kukreja August 31, 2013 at 1:05 am

Hi Varun,
The limit of Rs. 2 lakhs and Rs. 5 lakhs for Mutual Funds and Bonds was for each transaction earlier. Not sure about the current situation and how they are planning to do it. Also, I don’t think it has anything to do with the retail limit of Rs. 10 lakhs, as there are many NCD issues in which Rs. 5 lakhs is the limit for the retail investors, like Shriram Transport NCD issue.

Reply

Shiv Kukreja September 3, 2013 at 10:32 am

HUDCO has filed its Draft Shelf Prospectus on August 29th, so the issue is likely to hit the street in the next 15-20 days.

Reply

Varun September 3, 2013 at 12:19 pm

The interest rate would be lower than that of REC by at least 50 basis points due to falling 10 year yield in last 10 days. Is the interest rate mentioned in draft prospectus? Can there any link where we view the draft prospectus?

Reply

Shiv Kukreja September 3, 2013 at 12:48 pm

Hi Varun,

I don’t think the HUDCO rates would be lower than the REC rates. Firstly, the yield is to be calculated as the average yield of two weeks, ending on Friday immediately preceding the filing of the final prospectus, which is still ruling higher in the range of 8.30% to 9%. Also, HUDCO issue is rated ‘AA+’ vs. REC issue which is rated ‘AAA’, so that ways HUDCO can keep its rates higher by 10 basis points than any ‘AAA’ rated issue.

Interest rates are disclosed by the issuer just a few days before the launch, so it is not disclosed in the Draft Prospectus.
http://www.hudco.org/Site/FormTemplete/FrmtaxfreebondProspectus.aspx

Reply

Varun September 3, 2013 at 2:36 pm

Hmm.. should be around 8.4%. Let’s see.
So is the same prospectus released for private placement valid for general public issue too (of course with 25 basis point interest rate increase)?
As I see a company goes for private placement followed by general public issue. So does it mean there would be private placement of HUDCO after draft prospectus is approved and then the issue would open for general public?

Reply

Shiv Kukreja September 3, 2013 at 3:38 pm

Companies are not required to file prospectus for private placements. Also, it is HUDCO’s discretion whether they want to go for private placement first or public issue.

Reply

Varun September 3, 2013 at 2:49 pm

As per http://www.financialexpress.com/news/hudco-plans-to-raise-up-to-12.50-bn-rupees-via-tax-free-bonds/1160230 ; today is book opening & closing of HUDCO private placement with interest rates for 10 year bonds at 8.11 per cent, 15-year bonds at 8.56 per cent and 20 year bonds at 8.47 per cent.

Reply

Shiv Kukreja September 3, 2013 at 1:05 pm

PFC is going for a private placement of its tax-free bonds on Friday. Rates are 8.11% for 10 years, 8.48% for 15 years and 8.44% for 20 years, which means PFC’s rates for its public issue would be 8.36% for 10 years, 8.73% for 15 years and 8.69% for 20 years.

Source: http://in.reuters.com/article/2013/09/03/pfc-bonds-idINL4N0GZ1GD20130903

Reply

Varun September 3, 2013 at 2:34 pm

REC is already way over-subscribed on day one itself. Issues coming at 8.5+% interest rates would be success.

Reply

Shiv Kukreja September 3, 2013 at 4:10 pm

Probably. It is still way to go. Let see how much appetite investors have. If HUDCO issue comes at 9%+ for 15 years, it would be a grand success.

Reply

Varun September 3, 2013 at 2:41 pm

NHB private placement is already done (http://articles.economictimes.indiatimes.com/2013-08-29/news/41582360_1_nhb-pvt-placement-tax-free-bonds). Similarly two tranches of IIFCL (http://www.mydigitalfc.com/personal-finance/its-raining-tax-free-bonds-926). Not sure of interest rates of both these.
IIFCL would be coming with public issue at month end but not sure if same interest rate as that of private placement would be applicable. NHB – still no word on public issue.
Companies have taken a lesson from Jan-Mar 2013 tax free bond failure that attractive interest rate is required to get investors. So this time they rushed in applications when yields spiked.

Reply

Shiv Kukreja September 4, 2013 at 1:40 pm

Hi Varun… one more factor is there. This time the CBDT notified the rules for tax free bonds much earlier than it did last year. Last time, it got notified in November and the first issue hit the markets in December. This time it got notified in August itself.

Reply

Vivek October 25, 2013 at 6:16 pm

Anyone invested in IIFCL through ICICIDirect and wanting to cancel bid can ask me. I have found out procedure to apply for cancellation. Money will come 12 days after closure of issue and no interest will be paid on the money so held till then.
After a lot of thought, I will not be cancelling my bid at IIFCL. So far I have invested in REC, HUDCO, IIFCL, NHPC giving only PFC the miss. If some much better issues come out, I will try to exit in secondary market. that way I will get an idea of liquidity too.

Reply

Singh October 25, 2013 at 8:05 pm

Hi Vivek,
Please tell what’s the procedure to withdraw bid through icicidirect. I wanted to but could not do so.

Thanks in advance

Reply

Vivek October 25, 2013 at 8:09 pm

Pls arrange to forward the scan image of the withdrawal request letter duly signed by the applicant giving details of application number, pan number , name of the investor ,number of bonds applied and the amount paid so that we can do the needful.

Pls address to Karvy Computer Share Private Limited and the payment will be return to your bank account after closure within 12 days time

Best Regards

M.Muralikrishna
General Manager |Corporate Registry|Karvy Computershare Pvt Ltd
Plot No 17-24 | Vittalrao Nagar|Madhapur|Hyderabad – 500081|India
P: +91 40 44655300 | M: +91 9177401071|F: +91 40 23431551

Reply

VikasG November 14, 2013 at 10:58 pm

Hi Shiv, Any news of upcoming tax-free bond issues? I have some corpus that I would like to invest in taxfree bonds.

Reply

Shiv Kukreja November 15, 2013 at 11:16 am

Hi Vikas,

5 companies, IIFCL, IRFC, NHB, NTPC & NHAI, are lined up to issue tax-free bonds. They are expected to launch these issues either in the remaining part of November or December. You’ll get the updates whenever any of the issues gets launched.

Reply

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