Many investors were left disappointed after state-run NTPC pre-closed its public issue of tax-free bonds due to oversubscription. The issue, which had a base size of Rs 400 crore, was oversubscribed 11 times on the opening day itself (September 23). The closing date of the issue was September 30.
But for investment advisors the huge response to the issue was not a surprise. They say that since overall interest rates are expected to head lower, other tax-free bonds set to come up later are likely to offer lower rates. NTPC's issue was the first tax-free bond issuance in this fiscal. NTPC is among the seven state-run entities, including NHAI and IRFC, which have been given permission to raise Rs 40,000 crore in the current fiscal through tax-free bonds.
"The interest rates on tax free bonds are decided on based on equivalent rates on the government securities in the last quarter. If interest rates go down, future tax free bonds will come with lower rates," said investment adviser Harsh Roongta.
Tax-free bonds are usually issued by government-backed entities to raise long-term funding for infrastructure projects. The interest earned on these bonds does not attract income tax but investments made in tax-free bonds are not eligible for income tax deductions.
The NTPC issue had three tenures - 10 years, 15 years and 20 years. For retail investors the coupon or interest rate was 7.36 per cent for 10-year tenure, 7.53 per cent for 15 years and 7.62 per cent for 20 years.
Since the NTPC issue did not attract income tax on interest earned, the effective returns (after factoring in income tax impact) worked out to be higher than comparable rates on fixed deposits for those in higher tax brackets.
For example, India's largest lender State Bank of India currently offers 7.25 per cent interest on fixed deposits of tenures between 5 and 10 years. This means for those in the 30 per cent tax bracket, the effective return works out to be around 5 per cent.
On the other hand, the effective returns for those in 30 per cent tax bracket on NTPC tax-free bonds of 10-year tenure works out to be around 10.3 per cent.
Moreover, since the interest income on the bonds is tax exempt, no TDS (tax deduction at source) is levied, unlike bank deposits.
Apart from higher effective interest rate, the NTPC issue also offers the potential of capital gains because interest rates are likely to head lower, Mr Roongta said.
"It is also a reasonably good short-term opportunity because the market expects the interest rates to drop. If they actually drop, there will be a premium on these bonds. This issue is also likely to offer decent amount of liquidity at least over the next few months," he said.
The tax free bonds get listed on stock exchanges to offer exit option for investors. Capital gains made on selling of tax-free bonds on stock exchanges are taxed. If the holding period is less than 12 months, capital gains on sale of tax-free bonds on stock exchanges are taxed as per the tax slab of the investor. If bonds are held for more than 12 months, the gains are subjected to tax rate of 20 per cent calculated after reducing indexed cost of acquisition or 10 per cent of the capital gains without indexation of the cost of acquisition. (With Agency Inputs)
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