The tax-free bond issue of Rural Electrification Corporation (REC) offers an attractive opportunity for you to lock into low risk and superior tax-free interest income when compared with fixed deposits as well as post office schemes.
The 10-, 15- and 20-year bonds are available at 8.26%, 8.71% and 8.62% per annum respectively for both domestic and non-resident retail investors. For NRIs it is available on a repatriable and non-repatriable basis. The bonds are available for issue in both demat and physical form. Click here to buy through your FundsIndia account.
The rates are arrived at by reducing 55 basis points (for retail investors) from the reference G-Sec rates, as stipulated by laws governing these issues. It is noteworthy that the above rates are for retail investors (investment up to Rs 10 lakh). These rates are higher than the coupon offered for institutional and HNI category.
The issue
REC’s tax-free bonds are bonds on which the interest income does not suffer tax throughout the tenure. There is no tax benefit (such as 80C) on the principal. Most debt options, barring the PPF and EPF suffer tax on the interest component. Your FDs, post office schemes and corporate deposits are no exceptions.
In the case of REC, the coupon rate is actually the post-tax return for you. This makes these classes of bonds attractive for most tax payers.
Added to this, government security yields have been on a rise since July, thanks to the depreciating rupee. As tax-free bonds have to take in to account the G-Sec rates for reference, the current REC bond rates are higher than rates offered last fiscal. Currently 10-year G-Sec yields are at about 8.79% (close of Aug 29).
The 10 and 15-year coupon rates of similar bonds from REC issued in December 2012 were 7.72% and 7.88% respectively.
REC will issue Rs 1000 crore of bonds with an option to raise another Rs 2500 crore (totaling to Rs 3,500 crore), through this issue. At Rs 1000 a bond, the minimum subscription is Rs 5000. Interest will be paid out every year on December 1.
Low risk, high return
Coming from a Government of India Undertaking and granted AAA (highest credit rating) by multiple rating agencies including Crisil and ICRA, the tax-free bond is ideal if you are looking for a steady flow of income.
The table below shows the effective interest rate from bank deposits for a 10-year deposit available at 8.75% (rate offered by PSBs and others on an average). The yield on an 8.75% deposit works to 9.04% as the interest in compounded quarterly with FDs.
Clearly, the bond is tax-effective for all investors who pay tax irrespective of the slab in which they fall under.
REC is a public financial institution under the Ministry of Power, Govt. of India. It provides financing to all segments of the power sector, including power generation projects as well as independent power projects.
The company enjoyed lower cost of borrowing (as of FY-13) compared with peers and has adequate capitalization done by the government. It can also issue long-term infrastructure bonds besides tax-free bonds to raise money.
All its bonds are AAA rated. For FY-13, it total income (net of interest expense) was Rs 5590 crore up 35% over the previous financial year. Profits after tax rose 12% to Rs 3820 crore for the same period.
Strategy
As mentioned earlier, the bond is suitable if you are looking for regular sources of income. Even if you do not need the money, with some amount of discipline, you can ensure that you reinvest the interest income in short-term debt funds or income funds, based on your time frame. You can consider the 10 or 15-year option as they provide superior returns.
While these bonds can be sold in the stock market (you will incur capital gains), considering that the market for them is illiquid and you need to time your exits well, you may be better off holding the bond till maturity.
The offer closes on September 23. The company may choose to pre-close it.
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Hi,
I am a person who falls in 30% tax bracket. Why would this tax free bonds will be beneficial for tax purposes for me if NCD of AAA rated private companies with yield of 10% can be availed by FMD/debt funds. I can certainly take advantage of indexation in debt funds to bring down my tax liability.
Why should a person in 30% tax bracket should invest in such bonds. Do you think that CPI is going to decrease drastically in next 5 years? Or are there some rules in DTC which would impact taxation of debt mutual funds?
I always invest in growth option of debt mutual funds and never in divident option. So dividend distribution tax is not much of a concern for me.
Hello Sanjay,
First, these bonds are suitable for those who are comfortable only with fixed return products. Mutual funds do not guarantee returns, although agreed they hold potential to generate superior returns, given capital gains indexation benefit. Two, a 10% NCD will still yield arounf 7% and odd for someone in the 30% tax bracket. In that sense, among fixed instrument products (outside of those with 80C benefits), this tax-free bond is a good option. three, unlike PPF or NSC where there is no payout, the bond provides annual payout and is a good option for someone looking for such regular income.
A person comfortable with mutual funds and looking for wealth building should certainly stick to mutual funds. Thanks.
Hi ,
Can you please let me know where should i deposit the form and mode of money transfer ?
Thanks.
Hi,
I am a person who falls in 30% tax bracket. Why would this tax free bonds will be beneficial for tax purposes for me if NCD of AAA rated private companies with yield of 10% can be availed by FMD/debt funds. I can certainly take advantage of indexation in debt funds to bring down my tax liability.
Why should a person in 30% tax bracket should invest in such bonds. Do you think that CPI is going to decrease drastically in next 5 years? Or are there some rules in DTC which would impact taxation of debt mutual funds?
I always invest in growth option of debt mutual funds and never in divident option. So dividend distribution tax is not much of a concern for me.
Hello Sanjay,
First, these bonds are suitable for those who are comfortable only with fixed return products. Mutual funds do not guarantee returns, although agreed they hold potential to generate superior returns, given capital gains indexation benefit. Two, a 10% NCD will still yield arounf 7% and odd for someone in the 30% tax bracket. In that sense, among fixed instrument products (outside of those with 80C benefits), this tax-free bond is a good option. three, unlike PPF or NSC where there is no payout, the bond provides annual payout and is a good option for someone looking for such regular income.
A person comfortable with mutual funds and looking for wealth building should certainly stick to mutual funds. Thanks.
Hi ,
Can you please let me know where should i deposit the form and mode of money transfer ?
Thanks.
hi vidya..
nice and informative write up..but is it advisable to invest in these bonds if you plan to liquidate in span of 2-3 yrs considering return is still good vis-a-vis bank fd? and what about overall benefit to HNIs on same basis?
Hi ambika, the REC tax-free bond has a min. 10-year tenure. While it can be sold in the secondary market, it has liquidity issues. Hence for your time period, NCDs may be better if you have some risk appetite. Otherwise look for good corporate deposits. For HNIs, tax-free bonds are good only if they want the annual income flow. they cannot build wealth using this as there is no cumulative option. thanks
Hi Vidya,
What is your view on the risks associated to the on-going HUDCO tax free bonds – they look very attractive but if you go through the risks mentioned in the prospectus, they dont look secure enough. Highly appreciate your thoughts on this.
Thanks.
Hi Pinaki,
Yes, the rating of HUDCO is one notch below the earlier issue from REC. But the rates are therefore high. AA+ is a good enough investment grade rating, esp. given that the company is backed by the Government. The slightly lower rating is because of he inherent risks in the sectors in which the company lends – namely power, infrastructure besides realty. But healthy capitalisation and liquidity should not worry you much. thanks
hi vidya..
nice and informative write up..but is it advisable to invest in these bonds if you plan to liquidate in span of 2-3 yrs considering return is still good vis-a-vis bank fd? and what about overall benefit to HNIs on same basis?
Hi ambika, the REC tax-free bond has a min. 10-year tenure. While it can be sold in the secondary market, it has liquidity issues. Hence for your time period, NCDs may be better if you have some risk appetite. Otherwise look for good corporate deposits. For HNIs, tax-free bonds are good only if they want the annual income flow. they cannot build wealth using this as there is no cumulative option. thanks
Hi Vidya,
What is your view on the risks associated to the on-going HUDCO tax free bonds – they look very attractive but if you go through the risks mentioned in the prospectus, they dont look secure enough. Highly appreciate your thoughts on this.
Thanks.
Hi Pinaki,
Yes, the rating of HUDCO is one notch below the earlier issue from REC. But the rates are therefore high. AA+ is a good enough investment grade rating, esp. given that the company is backed by the Government. The slightly lower rating is because of he inherent risks in the sectors in which the company lends – namely power, infrastructure besides realty. But healthy capitalisation and liquidity should not worry you much. thanks
I would say that you can build wealth using bonds as well. The key to build wealth is to diversify. Putting all your eggs in one basket is too much risk. While debt mutual funds offer lesser risk that equity mutual funds, over a 15-20 yr period they will always underperform equity funds. Having said that, the market may tank when you actually need the money thus reducing your “wealth” at that point in time. In order to have access to liquity or hedge against “timing” the market, the bonds will protect your capital for 10 yrs while providing you regular interval. You can choose to reinvest the interest you receive on bonds in equity or further bonds. Remember key is to diversify your investment, keep liquidity options open and to hedge the risks. Based on my age, I have diversified my investment to be 30% bonds, 20% equity and rest in liquidity, real estate and gold. Slow and steady wins the race. Dont try to time the market. When you really needs funds in life, market may have tanked.
I would say that you can build wealth using bonds as well. The key to build wealth is to diversify. Putting all your eggs in one basket is too much risk. While debt mutual funds offer lesser risk that equity mutual funds, over a 15-20 yr period they will always underperform equity funds. Having said that, the market may tank when you actually need the money thus reducing your “wealth” at that point in time. In order to have access to liquity or hedge against “timing” the market, the bonds will protect your capital for 10 yrs while providing you regular interval. You can choose to reinvest the interest you receive on bonds in equity or further bonds. Remember key is to diversify your investment, keep liquidity options open and to hedge the risks. Based on my age, I have diversified my investment to be 30% bonds, 20% equity and rest in liquidity, real estate and gold. Slow and steady wins the race. Dont try to time the market. When you really needs funds in life, market may have tanked.