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
After a gap of one year, tax free bonds would be making a comeback this year. Central Board of Direct Taxes (CBDT) on July 6 issued a notification in this regards and allowed seven CPSEs to mop up Rs. 40,000 in the remaining nine months of the current financial year.
These CPSEs include NHAI, IRFC, HUDCO, IREDA, REC, PFC and NTPC. Out of total Rs. 40,000, NHAI alone would be mopping up 60% chunk of the total allowed amount to be raised i.e. Rs. 24,000 crore worth of bonds. IRFC would raise Rs. 6,000 crore, HUDCO Rs. 5,000 crore, IREDA Rs. 2,000 crore and REC, PFC & NTPC Rs. 1,000 crore each.
Here is the link to the Notification No. 59/2015 – Tax-Free Bonds Notification – FY 2015-16
Before we check the advantages of tax-free bonds vis-a-vis fixed deposits, let us first focus on the main points of the notification:
Tenure of Bonds – These bonds will be issued for a period of 10, 15 or 20 years.
Interest Rate Ceiling – Interest rates offered by these companies will be subject to a ceiling on the coupon rates based on the reference Government Security (G-Sec) rate. The ceiling coupon rates would be as under:
AAA Rated Issuer – Reference G-Sec Rate minus 55 Basis Points (or 0.55%) for RIIs
AAA Rated Issuer – Reference G-Sec Rate minus 80 Basis Points (or 0.80%) for Other Investors
AA+ Rated Issuer – Reference G-Sec Rate minus 45 basis Points (or 0.45%) for RIIs
AA+ Rated Issuer – Reference G-Sec Rate minus 70 basis Points (or 0.70%) for Other Investors
AA or AA- Rated Issuer – Reference G-Sec Rate minus 35 basis Points (or 0.35%) for RIIs
AA or AA- Rated Issuer – Reference G-Sec Rate minus 60 basis Points (or 0.60%) for Other Investors
Here, the reference G-Sec rate will be the average of the base yield of G-Sec for equivalent maturity period, reported by FIMMDA on a daily basis prevailing for two weeks ending on the Friday immediately preceding the filing of the final prospectus with the Exchange or Registrar of Companies (RoC).
These ceiling rates will be applicable for annual payment of interest. In case the payment of interest is made on a semi-annual basis, the interest rates will have to be reduced by 15 basis points (or 0.15% per annum). Moreover, in case the bonds are sold or transferred by a retail individual investor (RII) to a non-retail individual investor, the interest rate applicable will be reduced accordingly by 0.25%.
Eligibility – As per the notification, the following investors will be eligible to subscribe to the bonds:
(i) Retail Individual Investors (RIIs)
(ii) Qualified Institutional Investors (QIBs)
(iii) Corporates (including statutory corporations), trusts, partnership firms, limited liability partnerships (LLPs), co-operative banks and other legal entities, subject to compliance with their respective Acts
(iv) High Networth Individuals (HNIs)
Retail Investment Limit – Individual investors, including HUFs through Karta, investing upto Rs. 10 lakhs in a single issue will be considered Retail Individual Investors (RIIs). Above Rs. 10 lakhs of investment, these individual investors will be categorised as high networth individuals (HNIs) and will earn a lower rate of interest.
NRI Investment – Non-Resident Indians (NRIs) will be allowed to invest in these bonds, on repatriation basis as well as non-repatriation basis.
Public Issues – At least 70% of the money to be raised by each individual company will be raised through public issues and rest of the money they can raise through private placements.
Credit Rating – These issues will be rated by a credit rating agency which is approved by the Securities and Exchange Board of India (SEBI) as well as the Reserve Bank of India. In case the issuer is rated by more than one rating agency, the lower of the two ratings will be considered.
Expected Rate of Interest – Power Finance Corporation (PFC) on July 14 raised Rs. 300 crore through a private placement at 7.16% for a 10-year maturity period. The Company had also fixed 7.39% coupon for 15-year bonds and 7.45% coupon for 20-year bonds. Had it been a public issue, the retail individual investor would have got these bonds offered at 7.41% for 10 years, 7.64% for 15 years and 7.70% for 20 years.
What makes Tax-Free Bonds Popular?
Tax-Free Interest – Unlike fixed deposits (FDs), interest earned on these bonds is exempt from income tax for the investors. This is what makes these bonds highly popular among the tax paying retail investors and high net worth individuals (HNIs).
Scope of Capital Appreciation – There is no scope of capital appreciation with bank fixed deposits or company deposits as such investments are not directly linked to interest rate movement in the bond markets. Unlike bank/company deposits, tax free bonds get listed on the stock exchanges and their market value goes up when there is a fall in the interest rates.
Tax Free Bonds issued during FY 2013-14 with coupon rate of 8.75% to 9% have been trading at a premium of 15-25% apart from their regular interest payments.
Easy Liquidity – With tax-free bonds, you can sell your bond holdings whenever you want to. These bonds get listed on the stock exchanges and due to big issue sizes, these bonds can easily be sold whenever required.
Highest Credit Rating – These bonds get issued by the public sector enterprises most of which are AAA rated. So, from the safety point of view, these bonds are highly secured and attract a big number of risk-averse investors. To me, it makes perfect sense to invest in these bonds as against riskier company deposits.
Tax-Free Bonds to be issued this year would not carry as attractive interest rate as they did in 2013-14. The 10-year G-Sec yield has come down by more than 100 basis points or 1% since then. I do not expect these bonds to carry coupon rates above 7.75-8%.
With crude prices coming down once again, Monsoon rains being above expectations and inflation remaining under control, I think the interest rates would remain under pressure going forward as well. So, it is in the interest of the investors and these companies also if these bond issues get launched as soon as possible. Are these companies already working on that?
Application Form for Tax Free Bonds
Note: As per SEBI guidelines, ‘Bidding’ is mandatory before banking the application form, else the application is liable to get rejected. For bidding of your application, any further info or to invest in tax-free bonds, you can contact me at +919811797407
It seems NTPC is coming out with tax free bonds soon
If not in the second half of September, we’ll have at least 2-3 issues in October for sure.
Agreed, Mr George, and that’s why I had pointed this query to Mr Shiv. The interest rate on the said instrument, when seen on a cumulative basis, is over 13%. But yes like you rightly say, once you take into account the annual interest, this comes down to 9pc, give or take – depending on how you approach this calculation. This is something I wanted to confirm and compare…
Normally cumulative FDs are not for more than 5 years. This one is for 10, which makes it appear interesting.
Happy to know that you are in agreement. Many of the deposits by financial institution mentions cumulative yield based on compound interest which sometimes misleads investor. Since this forum is for sharing info, I have replied to your concern considering that Shiv can always share his thoughts if it fits. If my response was helpful it is fine, Shiv can always clarify.
Hi Mr. Comparison,
I think it is highly unjustified on PNB Housing’s part to quote a tentative YTM of 13.03% with its 10-year deposit scheme. In this scheme, your money earns 8.70% every year, which is taxable and grows by 2.303 times by the end of 10 years. I think 13.03% is just a simple interest and not an annual yield which the investors would be getting.
I believe it is more like a misrepresentation which PNB Housing is doing by calling it a tentative YTM of 13.03%. In fact, I think PNB Housing is misguiding its investors in this manner and the regulator is sitting silent about it.
8.70% p.a. for a non-tax payer is good, but not for those who are in 20-30% tax bracket and seek high post-tax returns. Apart from high tax-free returns, tax-free bonds carry scope of capital appreciation, provide easy liquidity, no TDS gets deducted and much more.
This is an interesting debate. Leaving aside misleading terminology used, as Shiv has said, the fact is interest earned is 13.03 % simple interest per year. Even if one is in 30% bracket, one would earn a simple interest of 9% per year. Is it not better than TFB tax free interest of say around 7.5%, leaving aside factors like safety etc.
You comments purely from financial return angle, without any bias please.
Thanks.
Hi George.
Our investment objectives can be different, and that doesn’t mean one of us has to be ignorant. I may not have any use for a 7pc+ cash interest paid out annually on these bonds, which may as a result lie idle in my bank account, earning me almost nothing. So I may want to evaluate that option vs an almost 9pc annualized, received post tax on a cumulative fixed deposit, after completing 10 years.
Your less-than-smart comment assumes you know other people’s preferences, and can pass judgement…
Mr. Comparison,
I have no issue with you or anyone and the intention was not to put down your view or pass a judgement. I may not be in a position to judge what is your background and how you look at yield calculation. You may be right in saying that 10 year investment and cumulative yield may be one’s priority. But the same is taxed on annual basis which may result in less yield. Any way, my apologies if you have got offended by my comment. May be Shiv can throw some light on the confusion.
Hi
Do you have any idea of issuance for First issue.
Regards
Piyush
HUDCO and NTPC will be coming up with TF bonds in Sep mostly 3rd or 4th week. Coupon rates are expected to between 7.4 to 7.8 for 1-20 years bonds.
Thanks George for this info!
When is the first public issue expected?
Is first half of september still holds?
Hi Shiv. Not a major digression to this subject…
How would you compare these tax free bonds with say PNB housing finance fixed deposits, which on a 10 year cumulative deposit, earn 13%+, meaning the post tax earnings are more than 9 percent. Thanks.
Mr. Comparison, How can you compare 10year Cumulative yield with annual yield and compute post tax return? Hope you wrote this because of your ignorance. No company is giving annual yield of 13%.
NHAI tax-free bonds assigned ‘AAA’ rating by India Ratings – http://www.business-standard.com/article/pti-stories/ind-ra-assigns-ind-aaa-rating-to-nhai-s-tax-free-bonds-115090200680_1.html
Dear Mr Shiv Kukreja,
Request you to please advise whether it is advisable to buy existing Tax Free Bonds from the Market considering their higher price, & at premiums at around 20% to issue price + Brokerage @1%. I am in the 30% Tax bracket.
Why are brokerage charges higher at 1% for tax-free bonds as compared to Equities?
Can you suggest the best Bank Linked Real-time Brokerage with least brokerage/transaction charges where we can buy even a single share without being loaded with a minimum charge of Rs 35 like ICICI does?
Thank you.
Hi S.K.,
It is a difficult call to make, but I think it is better to buy these bonds from the company itself rather from the secondary markets. I am not aware why the brokerages are charging high brokerage on these bonds/NCDs. It is something which only brokerages can answer. Also, I have not gone deep into such thing which tells me the cheapest brokerage house to buy these bonds/NCDs. But, I think discount brokerages such as Zerodha, SAMCO etc. must be charging a lower fee for such transactions.
rec will also coming up with a bond issue through private placement issue so when retail inveters will get chance to subscribe any bond issues I think it is very late
Hi Shiv,
Thanks for your comments. Do keep us informed regarding upcoming tax free bonds. Your updates and expert comments/advice are like oxygen for me, and I’m sure for many of us as well, when it comes to making financial investments. Thanks once again.
Regards,
SB
Thanks SB for your kind and motivating words! 🙂
Hi Shiv,
Any idea which banker is placing the NTPC bonds on a private placement and if there would be a retail issue?
Thanks,
AB
Hi AB,
I have no idea which company acted as the banker for NTPC’s private placement. But, as 70% of its allocated amount has to be through public issue(s), retail investors will definitely get a chance to participate.
Hi Shiv,
Why is that Hudco has AA+ and not AAA inspite of being a Govt Company.
Thanks,
Anuj
Hi Anuj,
It is not necessary for every government company to have a ‘AAA’ rating. These ratings are based on the fundamentals & credit worthiness of a company. There are many government companies which are fundamentally very weak & reporting losses/low profits, those companies do not deserve to be rated even AA+.
Thanks Shiv.
What if a govt. company defaults? Is there a chance that investors don’t get paid.
Hi Anuj,
Nobody can claim that a government company cannot default. It is possible that deteriorating fundamentals may force a government company to default on its payments. But, I am yet to see such a situation. With government backing, such companies normally pay back interest and principal on time.
Thanks Shiv. I really admire your frank and useful responses.
Good discussion. Useful info
Thanks Mr. Jain!
Any news on upcoming TF bonds?
Hi SB,
HUDCO and PFC are planning to come out with their respective issues in the first half of next month.
It seems HUDCO will be the first to come out with its tax-free bond issue. The company has appointed Edelweiss as one of the lead managers for its tax free bond issue.
Will issue come up in Aug?
Don’t know which month it will come.
irfc have also raised 7.19% coupan rate through a private placement issue so will they will come with another taxfree bond issues for retailer
.
Good Shiv, you have initiated the thread on Tax Free Bonds. 2013 was an excellent year for those who wanted to go long term or make some quick returns. As things stand, the interest rate for these bonds to be issued will be in the range of 7.5% to 7.8% for retail investors. But in 2013 also initially everyone expected the interest rate to be in the range of 7.8% 8.2%. But once the bonds started hitting the market, the scenario changed and we had interest rate in the range of 8.4 % to 9%. This time around we can not expect such scenario, but definitely it can go to 7.8% to 8.3% range considering the amount of supply of Corporate bonds and Tax free bonds planned, Possible hike of interest rate by US. RBI reluctance to reduce rate considering the inflation. Considering that there will be many issuers and multiple issues expected , one should plan and invest. Should not put your full investments in 01st or 2nd issue.
Hi George,
In 2013, the coupon rates increased later on due to a panic created due to the concerns of the US Fed’s decision of hiking interest rates and the government’s inability to control the situation. Currently, I think the economy is struggling and despite negative news creating all sort of pressures, inflation and interest rates are not moving up. This time around, the biggest threat is China’s slowdown. Still I think interest rates should go down going forward. Let’s see how things move in the next few months.
Dear Shiv,
I agree with you that the interest rate went up due to various internal and external factors at that time. At present also Fed Hike, China etc is very much on cards. The Inflation was under control due to low crude price and exchange stability. Some of the decisions the previous govt taken at the time of the crisis and the continuation of some good policies by the present govt and also the RBI. Though 75 basis points was reduced by RBI, Govt bonds are at around 8%. Still there is a chance of Tax free bonds being offered at around 8% for Retail investors in some of the issues. Lets hope for best.
Is there any existing bonds which we can invest which provides good YTM?
Hi Pradeep,
Most of the previous tax-free bond issues are yielding in the range of 7.10% to 7.40%. You’ll have to explore such opportunities in the bond market – http://www.nseindia.com/live_market/dynaContent/live_watch/equities_stock_watch.htm?cat=SEC
If Pradeep is not looking for investment above 100 Lakhs, better wait for new issues. It is better to buy issues considering that you will spend another 0.5% to 1% in brokerage. Your YTM comes down further. You will definitely get a better offer in IPO.
Hi. Any idea when, meaning in which months, would you expect these offerings to hit the market. Thanks.
Hi,
No company has yet announced any timeline for their issues. So, I would like not to speculate on their timings. However, as NHAI is required to raise Rs. 24,000 crore, I think the company would start exploring its options sooner than later. Also, November, December and January are the peak months for such issues.
thanks for excellent article
1.kindly guide us how to invest in this bond once they are open for allotment
2.is demat account must for investing in these bonds
3. what is average time given for allotment is it on fcfs basis??
Hi Sonia,
1. Sure, as & when an issue opens for subscription, I’ll post an article giving information on how to subscribe for tax-free bonds.
2. Demat account is not compulsory for investing in these bonds. You can apply for these bonds in certificate form as well.
3. Yes, it is on a FCFS basis.