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Suresh Krishnamurthy

Tax Saving Bond: Avoid

INVESTORS can avoid the Tax Saving Bond of IDBI. The rate on offer is lower compared to other competing options such as those from Power Finance Corporation and Rural Electrification Corporation. Moreover, removal of Section 80-L will ensure that interest income is taxed from next year. This will bring down the yield-to-maturity substantially.

Tax Saving Bond: The coupon rate on other bonds offered by IDBI has factored in the change in interest rate outlook only partially. The mark-up over the yield-to-maturity of government securities is less than a percentage point.

Compared to the offer made in January, IDBI has increased the coupon rate by 0.3 percentage points to 5.8 per cent. It is, however, still not attractive. This is because competing investment options, such as those of Power Finance Corporation and Rural Electrification Corporation, offer 6 per cent.

Thus, on pricing alone, the bonds offered by REC and PFC appear superior. In terms of safety, bonds of IDBI, considering the favourable changes impinging its financial health and its diversified lending profile, are superior to the other two. The status of wholly-owned Government of India undertakings enjoyed by the two firms that lend to the power sector, however, increases their safety factor considerably. As such, investments in REC or PFC can be considered. For those who have already invested in REC Bonds in earlier years, PFC would be a suitable alternative.

The effect of the removal of Section 80-L also needs to be considered. IDBI has mentioned that the yield-to-maturity for the five-year annual interest bond is 9.73 per cent. This does not, however, consider the tax that would be payable on the interest received. For salaried taxpayers, some amount of tax will become payable from next year. If they pay a tax of 10 per cent on the interest received, then the yield maturity will decline to 9.1 per cent. If they pay a tax of 20 per cent, the yield-to-maturity will fall to 8.4 per cent. For the deep discount bond, the after-tax yield for an investor in the 10 per cent and 20 per cent tax bracket would be 8.8 and 8.2 per cent respectively.

Removal of Section 80-L will affect competing investment options such as Power Finance Corporation and Rural Electrification Corporation, too. Investors can, however, redeem the bonds issued by the power sector financing firms after three years. In the case of IDBI bonds, considering the lack of liquidity in the secondary markets, they would have to stay invested for five years.

In addition, the yield on offer continues to be below what is offered by Regular Income Bonds. There is also, thus, less justification to invest in these purely as an investment option without taking into account tax benefits.

IDBI is offering such a low coupon rate because of the tax benefits on offer and also because only a handful of firms can offer infrastructure bonds. From the following year, the menu of available investment options will increase sharply and investors will no longer have to invest in such infrastructure bonds just to save tax.

The offer opened on March 21 and closes on 29. The deemed date of allotment for subscriptions to the Tax Saving Bond would be April 20.

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