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Infra bond: Look beyond the fine print

Sub head: Income earned from these bonds will be added to the taxable income in the year of redemption

The infrastructure bonds announced in this year’s budget are suddenly in the news. A number of issuers and their distributors are actively selling infra bonds nowadays, and there’s a great deal of advertising and coverage in the financial media about them. Unfortunately, despite the hype, these bonds are not actually a big deal for investors.

Yes, you can save tax ranging from Rs 2,060 to Rs 6,180, depending on your tax bracket, but that comes with a number of negatives, including some decidedly dodgy assumptions in the various sales pitches that you will come across.

I suspect that being attuned to the EEE (exempt-exempt-exempt) style of tax-saving investments, investors are not paying attention to the fact that the income earned from these bonds will be added to your taxable income in the year in which you realise it. In my opinion, all the advertising you see, which calculates the effective tax-adjusted yield of these bonds, is misleading to the point of being borderline fraudulent.

Why? Because the calculation cleverly assumes that you are in the 30 per cent tax bracket while investing in these bonds but quietly moves you the 0 per cent tax bracket while receiving the interest on the bonds can hardly be described as a shining example of honest selling. No advertisement or sales brochure even mentions the taxability of the income.

Anyone who is familiar with these products knows that the taxability of the income is being deliberately hidden from the investing public. Yet, this is exactly what every single issuer of these bonds and their sales agents are doing. No regulator or authority seems bothered by this.

Secondly, these bonds come with a long tenure of 10 years and a lock-in of five years. If there’s no convenient secondary market, then you will effectively have a lock-in of 10 years. Although some issuers will provide a guaranteed buyback, lock-ins of five years or above are the minimum.

Thirdly, unlike most fixed-income tax-saving investments, these bonds don’t carry any implicit or explicit government backing. Combined with the long tenure of these bonds, it will mean that the continued creditworthiness of the bond issuers is something that investors will have to keep an eye on.

As I have written earlier, a tax-saving investment has to be an investment first and a tax-saver later, in the sense that if you wouldn’t invest in that asset otherwise (taking the tax-saving into account), then you shouldn’t do so just because it’s saving some tax. Moreover, the upper limit of Rs 20,000 means that many taxpayers in the upper tax bracket will find that the quantum of additional tax savings to be marginal. All in the all, the detailed picture on these bonds is a lot less clear than the hype suggests.

This column first appeared in The Economic Times on October 25, 2010