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Last Updated : Jan 17, 2017 02:08 PM IST | Source: Moneycontrol.com

Tax free bonds are more attractive than other bonds

In the highest tax bracket it would still make sense to go in for the 6 per cent tax free bond because the final rate that they bear is still higher than what they would face otherwise.

Arnav Pandya

There are two types of bonds that are available for investors and their difference lies in the manner in which the taxation on these instruments take place. The bonds are tax free bonds and normal bonds and it is important for the investor to understand the manner in which they differ and also how should one identify the exact nature of the bond. There are various details that can help in this matter and hence this needs careful attention to each of them. Here is a look at some of the main points and how investors should be able to separate these to ensure that they are making the right investment choice.

Interest impact

The main difference between tax free bonds and other bonds is the tax impact of the interest that is earned on these bonds. In a tax free bond as the name suggests the interest that is earned would not be liable to be taxed and has to be shown in the column of tax free income in the return filed with the tax authorities. The impact of this is that the interest would not form part of the taxable income and hence there is no liability on the individual investor. In case of the other bonds the interest that is earned is taxable and hence the interest would have to be added to the other interest earned under the head of income from other sources. This would then be taxed and the applicable rate or slab for the individual would be used for the calculation since this becomes part of the normal income of the individual. This becomes the main difference for the income and one has to be very careful about the manner in which one handles the investment.

Actual interest

The interest that is offered on the bonds depends on the time period when they were issued and hence this becomes a factor which will enable one to distinguish between two types of bonds. A logical way to understand the situation is that if the interest on the bond is taxable then the final rate earned by the investor would be reduced by the tax rate applicable for them. So for example for someone falling in the 30 per cent tax bracket the 8 per cent available rate on a bond would come down to 5.6 per cent. This is the net or the final rate of return. As compared to this the tax free bond might just offer a 6 per cent interest rate to the investor. In this case for someone in the highest tax bracket it would still make sense to go in for the 6 per cent tax free bond because the final rate that they bear is still higher than what they would face otherwise.


The time period for which the bonds are being issued are also important for the investor in terms of understanding the nature of the investment. In most cases it is likely that the tax free bonds are for a longer time period and this can well stretch for a decade or more. On the other hand when it comes to the normal bonds they are likely to be issued for a time duration that is shorter and can range from 3 to 7 years. Looking at the time period is also important because the evaluation of the choices has to be done which would include looking at the time period. Too long a time period might create higher risk in some cases while in case of long term projects which is what the tax free bonds offer it is essential that there be a large number of years involved.
First Published on Jan 17, 2017 02:08 pm