The National Highways Authority of India (NHAI) is offering secured debentures that are redeemable after10 and 15 years. This is on offer for institutions and public at large, including non-resident Indians.

The bonds will carry an interest rate of 8.2 per cent an annum for the 10-year option and 8.3 per cent for 15 years. The unique characteristic of this bond offer is that the interest income, paid out annually, is not taxable. This is why they are called tax-free bonds.

It's different

Your interest income in most cases, whether from bank or company deposits or from debentures and bonds, is all taxable currently.

The NHAI bond therefore stands out for its tax-free interest income. It will pay you interest every year until maturity. The interest in your hands will be exempt from tax. Instruments of this kind are uncommon.

The bond will not get any benefit of tax deduction on investments made under Section 80C. It is also not an infrastructure bond like IDFC or IIFCL, which enjoys tax deduction for investments up to Rs 20,000 under Section 80CCF. You cannot also invest your capital gains in this bond, like the way you do with Capital Gain Bonds from REC or NABARD, and exempt yourself from capital gains tax.

The bonds are also tradable in the stock exchanges. Hence, if you choose to sell them in the market, you will incur capital gains tax similar to other listed debt securities. If sold within one year of purchase, short-term capital gains tax will have to be paid based on the normal tax slab.

Long term gains, if sold after a year, will be taxed at 10 per cent without indexing the cost. If you hold the instrument till maturity, you suffer no tax during the entire tenure of the bond.

Case for investment

You may find the interest rate of a little over 8 per cent unappealing at first sight. However, the tax-free status on income makes all the difference, especially if you fall under the 20-30 per cent tax bracket. For instance, if you have a bank deposit which earns you 11 per cent, then you effectively take home 7.7 per cent post tax. That's lower than what the NHAI bond offers. And remember, you get 11-12 per cent on your deposits only in the best of times, when interest rates have risen. The best rates are also not offered for tenure of over three years in most cases. For instance, any deposit over five years will return 9.25 per cent on an average with the best rates at 10 per cent for deposits of 5-10 years. That would still make for lower returns, post-tax, compared with the bond.

Twin benefits

Simply put, NHAI bonds offer you the twin benefits of fixed interest rates superior to many other traditional debt options and a lock-in into such rates for the long term.

Agreed, PPF is one other long-term instrument that offers superior returns of 8.6 per cent at present. Like NHAI bond, it is tax free. The investment made in PPF every year also enjoys deduction under Section 80C.

There are a couple of points, however, where NHAI bond scores over PPF. NHAI bonds are traded in the market and can be expected to be liquid, with 40 per cent and 30 per cent reservation to institutions and high networth individuals respectively. These investor segments can be expected to provide liquidity through trading. Public provident fund is highly illiquid, with restrictions on time and quantum of withdrawal.

You can invest up to Rs 5 lakh now in NHAI bonds as a retail investor. The bonds can also be bought when they are listed in the exchanges. Investment in PPF is restricted to Rs 1 lakh a year.

Allocation

NHAI Bonds can form part of any investor's debt allocation. The bond is ideal for investors, typically retired individuals, looking for a fixed income annually. For investors holding some lump sum that they can spare for the long haul, the bond is again a good option. Remember, your traditional post office schemes, beginning this year, will no longer give you fixed returns. Interest rates will vary annually.

For the tax-paying salaried class, the exemption of tax on interest income is a big bonus. But this segment of investors should continue their PPF investments and can consider investing any surplus in the bonds. High net worth individuals and those who have financial advisors can consider a more active strategy of selling a part of the bonds when interest rates go down. A fall in yield will trigger a rally in bond prices.

But this strategy is only for those who can make well-informed decisions. Otherwise, trading in bonds can be risky. The returns should be good enough to make up for or the capital gain tax suffered.

About NHAI

NHAI is an autonomous body under the Ministry of Road Transport and Highways. Bonds are therefore backed by the Government.

NHAI builds, maintains and operates highways, some of which are toll roads. It has been instrumental in awarding road development projects on a public private partnership basis. It allows private players to collect and enjoy the tolls and also receives its own toll revenue in some projects. But it holds all the road assets in its books.

The authority collected Rs 2,214 crore of toll revenues in FY-11. NHAI remits the toll to the government and receives the same back as capital every year.

The company has healthy cash flows as it receives cash through tolls. With capital grants, grant, budgetary support and cess from diesel and petrol, it is well capitalised. The company will raise up to 10,000 crore through this bond offer. Its debt, post issue, will be 0.3 times total capital.

Issue details

Offer period

December 28, 2011 to January 11 2012

Who can apply

Resident Indians and non-resident Indians (investment in rupee), institutions, trusts and societies

Lot size

Minimum of Rs 50,000 for retail investors (50 bonds of Rs 1,000 each face value) and then multiples of 1000

Allotment

30 per cent reserved for retail investors.

Allotment on a proportionate basis.

30 per cent reserved for HNIs. Allotment on first come basis.

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