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HUDCO – Tax Free Bonds – Tax Benefits

HUDCO – Tax Free Bonds – Tax Benefits

Disclaimer – Please Read the offer document carefully before investing.

INVESTORS DISCRETION IS SOLICITED – EXERCISE UTMOST CARE WHILE INVESTING. THIS IS FOR GENERAL INFORMATION.

Salient features of the bond issue (Tranche I)

a. Issue Opens on – January 09, 2013

b. Issue Closes on – January 22, 2013

c. The Bonds are issued in the form of tax-free, secured, redeemable, non-convertible bonds and the interest on the Bonds will not form part of the total income as per provisions u/s. 10 (15) (iv) (h) of Income tax Act, 1961.

d. CARE has rated the Bonds under this offer as “CARE AA+” and India Rating and Research Pvt Ltd (IRRPL) has rated the Bonds as “IND AA+”. Instruments with this rating are considered to have the highest safety regarding timely servicing of financial obligations.

e. The Bonds issued by the Company will be secured by a floating first pari passu charge on present and future receivables of the company to the extent of amount mobilised under the issue.  The Company reserve the right to create first pari passu charge on present and future receivables for its present and future financial requirements. The Company shall create DRR of 50% of the value of Bonds issued and allotted for the redemption of the Bonds.

f.  Issuance will be in DEMAT as well as Physical form. The bonds will be listed only on NSE facilitating trading of these bonds.

g. In case of over-subscription; The Allotment Shall Be On First Cum First Serve Basis For All Category Investors.

h. Investors can pledge or hypothecate these bonds to avail loans.

i. The Bonds bear an attractive coupon rate; 7.34% p.a. for 10 Years and 7.51% p.a. for 15 Years for Category I, II, III & IV Applicants along with Step up Coupon of 0.50% for Retail Investor investing upto Rs.10 Lakh.

j. IIFCL shall pay interest on application money on the amount allotted to the applicants other than ASBA applicants, at the rate of 7.34%p.a. and 7.51%p.a. on Tranche I Series 1 and Series 2 respectively for allottees under category I, II & III portion and at the rate of 7.84%p.a. and 8.01%p.a. on Tranche I Series 1 and Series 2 respectively for allottees under Category IV portion.

k. Interest on refund of application amount:  5% p.a. on the monies liable to be refunded to the applicants other than Application Amounts received after the closure of the Issue and ASBA applicants.

STATEMENT OF TAX BENEFITS

 Under the current tax laws, the following possible tax benefits, among other things, will be available to the Bond Holder. This is not a complete analysis or listing of all potential tax consequences of the subscription, ownership and disposal of the Bond, under the current tax laws presently in force in India. The benefits are given as per the prevailing tax laws and may vary from time to time in accordance with amendments to the law or enactments thereto. The Bond Holder is advised to consider in his own case the tax implications in respect of subscription to the Bond after consulting his tax advisor as alternate views are possible interpretation of provisions where under the contents of his statement of tax benefit is formulated may be considered differently by income tax authority, government, tribunals or court. We are not liable to the Bond Holder in any manner for placing reliance upon the contents of this statement of tax benefits.

A. INCOME TAX

1. Interest from Bond do not form part of Total Income.

a) In exercise of power conferred by item (h) of sub clause (iv) of clause (15) of Section 10 of the Income Tax Act, 1961 (43 of 1961), the Central Government vide Notification No. 46/2012/F.No.178/60/2012 – (ITA.1) dated November 6, 2012 authorizes Housing & Urban Development Corporation Ltd. to issue through Public/Private Issue, during the Financial year 2012-13, tax free, secured, redeemable, non-convertible bonds of Rs. 1,000 each for the aggregate amount not exceeding Rs. 5,000 crores subject to the other following conditions that –

(i) Tenure of Bonds: The tenure of the bonds shall be for 10 or 15 years.

(ii) Permanent Account Number: It shall be mandatory for the subscribers of such bonds to furnish their permanent account number to the issuer.

(iii) Registration with Issuer: The benefit under the said section shall be admissible only if the holder of such bonds registers his or her name and holding with the issuer.

(iv) Rate of Interest:- (a) There shall be a ceiling on the coupon rates based on the reference Government Security (G-Sec) Rate. The reference G-Sec Rate would be the average of the base yield of G-Sec for equivalent maturity reported by Fixed Income Money Market and Derivatives Association of India (FIMMDA) on daily basis (working day ) prevailing for two weeks ending on the Friday immediately preceding the filling of final prospectus with the Exchange or Registrar of Companies (ROC) in case of public issue and the issue opening date in case of private placement.

(a) The ceiling coupon rate for AA rated issuers shall be the reference G-Sec Rate less basis points in case of Retail Individual Investors (RII); and reference G-Sec less 100 basis points in case of other investors segement , like Qualified Institutional Buyers (QIBs), Corporate and High Net Worth Individuals (HNIs);

(b) In case the rating of the issuers entity is above AA , a reduction of 15 basis points shall be made in the ceiling rate compared to the ceiling rate for AA rated entities [as given in clause (a)];

(c) These ceiling rates shall apply for annual payment of interest and in case the schedule of interest payments is altered to semi-annual, the interest rates shall be reduced by 15 basis points;

(d) Interest Rate on transfer of Bonds: The higher rate of interest , applicable to retail investors, shall not be available in case the bonds are transferred , except in the case of transfer to legal heir in the event of death of the original investor;

(v) Minimum ceiling for Public Issue, Issue Expenses and Brokerages : (a) At least 75% of the aggregate amount of bonds shall be raised through public issue. 40% of such public issue shall be earmarked for retail investors;.

(a) Total issue expenses shall not exceed 0.5% of the issue size in case of public issue. The issue expenses would include all expenses relating to the issue like brokerages, advertisement, printing, registration, etc.

(b) The brokerage, in cases of different categories , shall be limited to the following ceilings:

(1) QIB- 0.5%

(2) Corporates – 0.1%

(3) HNI- 0.15%

(4) RII- 0.75%

b) Income do not form part of total income: (a) Section 10(15)(iv)(h) to be read with Section 14A(1) provides that in computing the total income of a previous year of any person, interest payable by any Public Sector Company in respect of such bonds or debentures and subject to such conditions, including the condition that the holder of such bonds or debentures registers his name and the holding with that company, as the Central Government may, by notification in the Official Gazette, specify in this behalf shall not be included.

Further, as per Section 14 A (1), no deduction shall be allowed in respect of expenditure by the assesee in relation to said interest, being exempt.

(b) Section 2(36A) of the IT Act defines ‖Public Sector Company‖ as any corporation established by or under any state Central, State, Provincial Act or a Government company as defined section 617 of the Companies Act, 1956.

c) TDS: Since the interest Income on these bonds is exempt, no Tax Deduction at Source is required. However, interest on application money would be liable for TDS as well as Tax as per present tax rules.

d) Accordingly, pursuant to the aforesaid notification inumerated above, interest from bond will be exempt from income tax.

2. Capital Gain

a) Under section 2 (29A) of the I.T. Act, read with section 2 (42A) of the I.T. Act, a listed Bond is treated as a long term capital asset if the same is held for more than 12 months immediately preceding the date of its transfer.

Under section 112 of the I.T. Act, capital gains arising on the transfer of long term capital assets being listed securities are subject to tax at the rate of 20% of capital gains calculated after reducing indexed cost of acquisition or 10% of capital gains without indexation of the cost of acquisition. The capital gains will be computed by deducting expenditure incurred in connection with such transfer and cost of acquisition/indexed cost of acquisition of the bonds from the sale consideration.

However as per third proviso to Section 48 of Income Tax Act, 1961 benefits of indexation of cost of acquisition under second proviso of section 48 of Income tax Act, 1961 is not available in case of bonds and debenture, except capital indexed bonds. Thus, long term capital gain tax can be considered 10% on listed bonds without indexation.

Securities Transaction Tax (―STT‖) is a tax being levied on all transactions in specified securities done on the stock exchanges at rates prescribed by the Central Government from time to time. STT is not applicable on transactions in the Bonds.

In case of an individual or HUF, being a resident, where the total income as reduced by the long term capital gains is below the maximum amount not chargeable to tax i.e. Rs 200,000 in case of all individuals including resident women, Rs 250,000 in case of resident senior citizens and Rs.500,000 in case of resident very senior citizens, the long term capital gains shall be reduced by the amount by which the total income as so reduced falls short of the maximum amount which is not chargeable to income-tax and the tax on the balance of such long-term capital gains shall be computed at the rate of  ten per cent in accordance with and the proviso to sub-section (1) of section 112 of the I.T. Act read with CBDT Circular 721 dated September 13, 1995.

A 2% Education cess and 1% Secondary higher education cess on the total income tax (including surcharge for corporate only) is payable by all categories of tax payers. All the rates disclose above are taken as per the present tax rates.

b) Short-term capital gains on the transfer of listed bonds, where bonds are held for a period of not more than 12 months would be taxed at the normal rates of tax in accordance with and subject to the provision of the I.T. Act.

The provisions related to minimum amount not chargeable to tax, Surcharge and Education cess described at (a) above would also apply to such short-term capital gains.

c) Under section 54EC of the Act and subject to the conditions and to the extent specified therein at present, long term capital gains arising to the bondholders on transfer of their bonds in the company shall not be chargeable to tax to the extent such capital gains are invested in certain notified bonds within 6 months from the date of transfer. If only part of the capital gain is so invested, the exemption shall be proportionately reduced. However, if the said notified bonds are transferred or converted into money within a period of 3 years from their date of acquisition, the amount of capital gains exempted earlier would become chargeable to tax as long term capital gains in the year in which the bonds are transferred or converted into money. Where the benefit of section 54 EC of the Act has been availed of on investments in the notified bonds, a deduction from the income with reference to such cost shall not be allowed under section 80 C of the Act. The investment made in the notified bonds by an assessee in any financial year cannot exceed Rs. 50 Lakh.

d) As per the provisions of Section 54F of the Income Tax Act, 1961 and subject to conditions specified therein, any long term capital gains (not being residential house) arising to Bond Holder who is an Individual or Hindu Undivided Family, are exempt from capital gains tax if the entire net sales consideration is utilised, within a period of one year before, or two year after the date of transfer, in purchase of new residential house, or for construction of residential house within 3 years from the date of transfer. If part of such net sales consideration is invested within the prescribed period in the residential house, then such gains would be chargeable to tax on a proportionate basis.

e) Under section 195 of the Income Tax Act, Income tax shall be deducted from sum payable to non residents on the long term capital gain and short term capital gain arising on sale and purchase of bonds at the rate specified in the Finance Act of the relevant year or the rate or rates of the income tax specified in an agreement entered into by the Central Government under section 90, or an agreement notified by the Central Government under section 90A, as the case may be.

However under section 196D, No deduction of tax shall be made from income arising by way of capital gain to Foreign Institutional Investors.

3. Profit and Loss

In case the Bonds are held as stock in trade, the income on transfer of bonds would be taxed as business income or loss / capital gain or loss in accordance with and subject to the provisions of the Income Tax Act applicable time to time.

4. Taxation on Gift

As per section 56(2)(vii) of the Income Tax Act, in case where Individual or Hindu Undivided Family receives bond from any person on or after 1st October, 2009

A. without any consideration, aggregate fair market value of which exceeds fifty thousand rupees, then the whole of the aggregate fair market value of such bonds/debentures or;

B. for a consideration which is less than the aggregate fair market value of the Bond by an amount exceeding fifty thousand rupees, then the aggregate fair market value of such property as exceeds such consideration;

shall be taxable as the income of the recipient.

Provided further that this clause shall not apply to any sum of money or any property received—

(a) From any relative; or

(b) On the occasion of the marriage of the individual; or

(c) Under a will or by way of inheritance; or

(d) In contemplation of death of the payer or donor, as the case may be; or

(e) From any local authority as defined in the Explanation to clause (20) of section 10; or

(f) From any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in clause (23C) of section 10; or (g) From any trust or institution registered under section 12AA.

B. WEALTH TAX

Wealth-tax is not levied on investment in bond under section 2(ea) of the Wealth-Tax Act, 1957.

C. PROPOSALS MADE IN DIRECT TAXES CODE

The Hon‗ble Finance Minister has presented the Direct Tax Code Bill, 2010 (DTC Bill‗) on August 30, 2010, which is likely to be presented before the Indian Parliament. Accordingly, it is currently unclear what effect the Direct Tax Code would have on the investors.

An Analysis on Tax Free Bonds V/S Tax Saving Bonds

At Present in Indian Market, Various Financial Institutes and Other Authorities are issuing various types of bonds such as Tax Free Bonds, Tax Saving Bonds.  

The Major Players in Tax Free Bonds are 

NHAI, 

Power Finance Corporation (PFC), 

Indian Railway Finance Corporation (IRFC) 

whereas in Tax Saving Bonds – 

L&T and IDFC are major players.

The basic difference between Tax Free Bonds and Tax Saving Bonds is:

• Tax free Bonds yields Interest which is not taxable in the hands of Investor whereas in case of Tax Saving bonds it is chargeable to Tax in hands of Investor.
• Investor gets Deduction under Section 80CCF if he invests in Infrastructure Tax Saving Bonds up to Rs. 20,000 whereas same is not available in case of Tax free Bonds.
•  

About Tax Free Bonds:

Recently National highway Authority of India (NHAI) has launched Tax free Infrastructure bond. The said bond is listed in NSE and BSE having “AAA” rating which represents highest safety and stability. It is for the very first time where NHAI has been allowed to raise Rs. 10,000 Cr. Through Tax free bond with a coupon rate of  8.2 % for 10 year and 8.3 % for 15 years which will be majorly used in acquiring land for various projects. It is needless to mention here that NHAI is allowed to raise fund through 3 Years 54EC bonds. The said bond has no minimum Lock-In-Period and investor can use exit routes by selling off the bonds on Stock Exchanges. Power Finance company (PFC) also opened its issue on 30^th December, 2011. It is offering rates similar to NHAI. PFC’s offer for bonds is last on 16^th January, 2012.

About Tax Saving Bonds:

Tax Saving Bonds – are instruments used for Individual Income Tax savings. They have not been as popular as some of the other Tax saving instruments, but are ideal for people who have low risk appetite and are looking to preserve their income in the longer run and also accrue benefit of tax savings. In Union Budget 2010-2011, a new section 80CCF was inserted under the Income Tax Act, 1961 – to provide for income tax deductions for subscription to long-term infrastructure bonds. These long term infrastructure bonds offer an additional window of tax deduction of investments up to 20,000. Recently L&T and IDFC have come up with an Issue for Tax-saving bonds.  There is Minimum Lock-In-period for 5 years in Tax Saving Bonds. Investor can sell it on stock exchanges post Lock-In/ buy back offers. The interest rates are 9% . L&T infrastructure bond assigned to credit rating as “AA+”, However IDFC infrastructure bonds have got the highest credit rating of “AAA”.

This article discusses the comparability and expected yields from tax free bonds, tax saving bonds and Bank Fixed Deposit.

On the face of it, these 8.2-8.3 % Tax-free bond issued by NHAI, PFC are very much comparable to other investments which yield 12% pre tax return. These bonds are even better than Bank fixed deposits, which are currently giving about 9% (pretax) returns. The aforesaid bonds are even better from Tax saving Infrastructure Bonds issued by L&T, IDFC, if we consider effective rate of return on the Bonds.

The example given below demonstrates the same.

EXAMPLE:

Assuming we are Investing Rs. 1,00,000 in each Three i.e. Tax Free Bonds, Tax Saving Bonds and Bank Fixed Deposit.  Let us assume that the said Investment is over and above Investment made under section 80C.

Let us compare the Return from each three investments one by one

√  Case I   :   Comparison of Tax Free Bonds with Bank FD

√  Case II   :  Comparison of Tax Saving Bonds with Bank FD

√  Case III  :  Comparison of Tax Free Bonds with Tax Saving  Bonds.

Case I:       Comparison of Tax Free Bonds with Bank F.D.

Analysis of Rate of Return
	Tax Free Bond	Bank FD
Investment	Rs. 100000	Rs.100000
Tax Saving (Assuming 30% tax slab) (A)	-	-
Interest Rate	8.20%	9.00%
Post tax Interest Rate	8.20%	6.22%
	(Tax Free)	(Taxable)
Interest Earning  (B)	8200	6219
Total Earning (A+B)	8200	6219
Effective Rate of Return	8.20	6.22

 Conclusion : Here Investment in Tax free bonds will yield ROR of 8.20% as compare to Bank fixed deposit which yield ROR @ 6.22%. Hence we can conclude that it is better to go for Tax Free bond because it gives us return of Rs. 8200/- as compare to Bank fixed deposit return which is only Rs.6220/- . Alternatively, We can say Tax Free bonds are yielding 132% return as compare to Bank fixed deposit. Here if we consider the span of 5 years, the aggregate return will be 41% (8.20 % *5 years) in case of Tax Free Bonds and 31.1% (6.22*5 years) in case of bank FD. As the return in hands of investor remain same, thus we can conclude that time horizon will not make any difference in earnings of the investor in the above case.

 Case II:     Comparison of Tax Saving Bonds with Bank FD

Analysis of Rate of Return
	Tax Saving Bond	Bank FD
Investment	Rs.100000	Rs. 100000
Tax Saving U/s 80CCF (Assuming 30% tax slab) (A)	6180*	0
Interest Rate	9%	9.00%
Post tax Interest Rate	6.22%	6.22%
	(Taxable)	(Taxable)
Interest Earning  (B)	6219	6219
Total Earning (A+B)	12399	6219
Effective Rate of Return	12.40	6.22

 (*Tax Saving: Rs 20,000 x 30.9 % Tax Maximum amount available as deduction is Rs. 20000 under section 80CCF.  Hence the maximum tax benefit that can be availed is Rs 6180/-.)

√ Conclusion: If we consider Investment at a span of One year the Tax Saving Bonds yields ROR @ 12.40% whereas yielding ROR for Bank fixed deposits is @6.22%. Hence we can conclude that it is better to go for Tax Saving Bonds because it gives us effectively Rs. 12400/- as compare to Rs 6220/- earned from Bank Fixed Deposits. Alternatively, We can conclude that Tax Saving Bond is yielding 199% return as compare to Bank Fixed Deposits.

√  Again if we consider period of 5 years the earning ROR of investor would be as follows in both the cases:

Aggregate Effective Rate of Return for five years

	Investment Option
Year	Tax Saving Bond	Bank FD
First year	12.40	6.22
Second Year	6.22**	6.22
Third Year	6.22	6.22
Fourth Year	6.22	6.22
Fifth Year	6.22	6.22
Aggregate Effective ROR for Five years	37.28	31.10

 **No deduction u/s 80CCF for 2^nd & subsequent years.

It is clear from above table that even from 2^nd year onwards ROR of both the option are same but the aggregate effective ROR for five years is higher in case of Tax saving Bonds as compared to Bank fixed deposit. This is because in the first year investor can claim deduction up to Rs. 20,000 which is not available in case investment made in Bank fixed deposit.

Case III:  Comparison of Tax Free Bonds with Tax Saving Bonds.

Calculation of Effective Rate of Return
	Tax Free Bond	Tax Saving Bond
Investment	Rs.100000	Rs. 100000
Tax Saving U/s 80CCF (Assuming 30% tax slab) (A)	-	6180*
Interest Rate	8.20%	9%
Post tax Interest Rate	8.20%	6.22%
	(Tax Free)	(Taxable)
Interest Earning  (B)	8200	6219
Total Earning (A+B)	8200	12399
Effective Rate of Return	8.20	12.40

(*Tax Saving: Rs 20,000 x 30.9 % Tax Maximum amount available as deduction is Rs. 20000 under section 80CCF.  Hence the maximum tax benefit that can be availed is Rs 6180/-.)

Conclusion: At a span of one year Tax Free Bonds yields ROR@8.20% whereas investment in Tax Saving Bonds yields ROR @ 12.40%. Hence we can say it is better to go for Tax Saving Bond because it yields effectively Return of Rs. 12400/- as compared to earnings of Tax Free Bonds which is Just. Rs. 8200/-.  However if period of five year is taken into consideration the scenario would be as follows:

Aggregate Effective Rate of Return for five years
Year	Tax Free Bond	Tax Saving Bond
First year	8.20	12.40
Second Year	8.20	6.22**
Third Year	8.20	6.22
Fourth Year	8.20	6.22
Fifth Year	8.20	6.22
Aggregate Effective ROR for Five years	41.00	37.28

** No deduction u/s 80CCF for 2^nd & subsequent years.

It is clear from above table that at a span of five years the overall return in the hands of the investor is higher in case of Tax Free Bonds as compared to Tax Saving Bonds and Bank Fixed Deposits. This is actually nothing but just an opposite of what conclusion we have drawn from one year calculation.

Thus we can conclude that Tax saving bonds may yield quite higher return than Bank FD and Tax free bond in the initial year but at the span of 5 years Tax Free Bonds yields higher rate of return.

However if we just consider Post tax rate of Interest, Tax free Bonds are best among other alternatives as the Interest earning of Tax Free Bonds are not chargeable to tax.