On premature sale of tax-free bonds, capital gains tax has to be paid

Will you please advice whether the tax-free bonds issued by HUDCO and IIFCL are subject to long term capital gains tax upon redemption after one or two years.
-Rajendra Shivpuri

The 'tax-free' promise of tax-free bonds holds only on the interest income that you are paid by the issuer. If you hold these bonds to maturity, derive only the interest income from them and get them redeemed from the issuer, then they are tax-free.

However, it's also possible to sell these bonds on the open market. If you do that, you will have to pay capital-gains tax on the profit you make. As per the law, cost-indexation is not available for tax-free bonds so you will be liable to pay a flat 10 per cent on the gains.

As a practical matter, the secondary market for such bonds is quite thin so the chances of being able to sell them prematurely are not great.

This article was originally published on January 22, 2014.