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What is the tax treatment of infrastructure bonds?

Tax-saving infrastructure bonds were introduced long back as an avenue to save taxes. Since many of them have started maturing, here is what you need to know about their tax implications.

Tax free infrastructure bonds: Tax treatment of infrastructure bonds

The government of India, in a bid to attract investors' money into the infrastructure sector, introduced section 80CCF of the Income-tax Act more than a decade back. This allowed an investor to seek tax relief on the investment amount up to Rs 20,000 per year by investing in specific Government approved infrastructure bonds. These bonds found prominence in Budget 2010 when they were introduced as an additional avenue to save taxes. However, what remains noteworthy is that the deduction for investment in infrastructure bonds was available only for a short period and was discontinued with effect from the financial year 2012-13.

The Government approved infrastructure companies issued these bonds with a decent rate of interest, added with tax benefits. The interest rate on the bond was guaranteed and varied across bond issuers. These bonds came with a long tenure of 10-15 years along with a lock-in of five years. Hence, these bonds were completely illiquid during the first five years, unless there was an unfortunate demise of the bondholder. These bonds were listed on the stock exchange and some infrastructure companies also offered a buyback option to the investors to offer liquidity after the lock-in of five years.

Since these bonds were launched between 2011-12, many of them have started hitting maturity. So here is what you need to know about their tax implications.

Tax liability for investors
While the infrastructure bonds provided tax benefit of up to Rs 20,000 under section 80CCF of the Income-tax Act at the time of investing, the interest earned on these bonds is fully taxable in the hands of the investor. The interest income is added to the total income of the investor and taxed as per their tax slab.

The investors have an option to hold these bonds in the demat mode or in physical form. Further, investors could also choose whether they wanted to receive interest annually or cumulatively on maturity. In the annual pay out option, investors need to pay tax on the interest received in the respective year and only the principal amount is returned on maturity. While under the cumulative option, the principal amount along with the accumulated interest earned is paid to the investors. Therefore, in this case, investors need to pay the tax on interest income on maturity.

TDS is not deducted for bonds held in the demat form. In case bonds are held in physical form, TDS will be deducted on interest on bonds where the interest paid or payable to a resident individual bondholder exceeds Rs 5,000 in a financial year.

Also read:
What is the tax treatment of the interest earned on NSC?
Taxation of corporate bonds

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