Tuesday, May 11, 2010

Should We Invest in the new Infrastructure Bonds that offer 80CCF Tax Benefits


With the new income tax rules in effect, one of the new additions using which a citizen can avail tax benefits is the Infrastructure Bonds that can be till the amount of Rs. 20,000/- for a financial year. So, for a person in the highest tax slab (30%) the tax benefit because of this investment would be around Rs. 6000/- per year.

Before we get into the details as to whether we must invest in these bonds or not, let us find out what these bonds are and how we can invest in them.

What are Infrastructure Bonds:

Infra Bonds are like any other bond that is available in the debt market for purchase with the only difference being the fact that, the funds collected through the sale of these bonds is used for the infrastructural development of India. Hence, to promote more investment in this segment, the government has come up with the tax benefit so that investors would invest in these bonds.

Where to Buy:

You can buy them from the branches of ICICI and IDBI banks. ICICI also offers electronic sale of these bonds where investors with DEMAT accounts can buy them.

Should we Buy these Infrastructure Bonds:

Actually, this is not such a simple question to answer. Let me elaborate why…

A Bond is a debt instrument which pays a periodic/fixed interest which doesn’t change very frequently. It is like Bank Fixed Deposits. So, depending on what income slab you fall under, the answer as to whether to buy these or not would vary.

Let us consider 3 people – Mr. A, Mr. B and Mr. C. These are 3 people who fall under the 3 tax slabs in our Indian Tax Laws. All 3 of them invest Rs. 20,000/- in these infrastructure bonds.

Other Assumptions:
Returns on the Bonds – 8% (Returns on the actual bonds may vary between 6% and 9%. I am taking 8% because that is approximately the rate of returns most debt instruments give us per year)

Annual Inflation Rate – 10% (The Actual inflation rate of our country is much higher, but still I am keeping this at 10% as an average because the fiscal measures taken by our government would bring down the inflation sooner or later)

Lock In Period – 3 years (The actual lock in period may vary from bond to bond)

Interest Compounding – Annual Compounding (The actual interest compounding may vary from bond to bond. I am keeping it annual for ease of calculations)

Let us go through the results of their investments before deciding on who must buy these bonds.

For Mr. A:

Tax Saved (@10%) = Rs. 2,000/-
Interest earned in 3 years = Rs. 5194.24/-

Net Profit on Investment = Rs. 7194.24/-

Average profit per year = Rs. 2398.08/-

Which is approximately 11% returns per year. Considering the fact that the inflation is running at more than 10% per annum, actually there is no growth in your investment at the end of 3 years. Even if we consider that inflation was constant @ 10% every year, your investment has grown by 1% every year.

For Mr. B:

Tax Saved (@20%) = Rs. 4,000/-
Interest earned in 3 years = Rs. 5194.24/-

Net Profit on Investment = Rs. 9194.24/-

Average profit per year = Rs. 3064.75/-

Which is approximately 15% returns every year. Considering the fact that, the inflation is @ 10%, your investment would grow at approximately 5% every year.

For Mr. C:

Tax Saved (@30%) = Rs. 6,000/-
Interest earned in 3 years = Rs. 5194.24/-

Net Profit on Investment = Rs. 11,194.24/-

Average profit per year = Rs. 3731.41/-

Which is approximately 18.7% returns every year. Considering the fact that, the inflation is @ 10%, your investment would have grown at a handsome rate of 8% every year.

Conclusion:
If you are in the highest tax bracket (30%) then these infrastructure bonds are a definite YES as part of your portfolio. A SAFE AND SOLID INVESTMENT OPTION.

If you are in the medium tax bracket (20%) then you can have a decent allocation (say Rs. 10,000 every year) as part of your portfolio. A SAFE INVESTMENT OPTION.

If you are in the lowest tax bracket (10%) then it is better if you stay away from them.

Happy Investing!!!

8 comments:

  1. i checked icici and idbi banks websites, no information about the infrastructure bonds, please could you let me know where can i buy this.

    ReplyDelete
  2. Karthik - Please check a DEMAT/Investment account. Or visit a bank branch. I remember seeing options to buying infrastructure bonds in ICICI Demat.

    ReplyDelete
  3. Very useful. Thank you Anand. I voted for you.

    ReplyDelete
  4. Understand what a bond is. A bond is a interest-bearing certificate, issued by either government agencies (these are known as treasury bonds, agency bonds, municipal bonds, etc.) or business corporations (these are known as corporate bonds), which pays a fixed amount of interest on specified dates, usually every six months, until maturity or redemption. Treasury bonds have no risk of default (because the government controls the money printing press and can print whatever money it needs to pay the interest or principal on its bonds), while corporate bonds carry the risk of default on interest, principal, or both.

    ReplyDelete
  5. Are these bonds to be purchased in that financial year? I mean Can I use the last finance year's bond purchase for this finance year?

    ReplyDelete
  6. @ Parag

    See answers below:

    Are these bonds to be purchased in that financial year? - You can purchase them anytime

    I mean Can I use the last finance year's bond purchase for this finance year? - No. Bonds purchased in a financial year - April 1st to March 31st can be used for tax exemption only for the corresponding duration. Every purchase can be used for tax exemption only once.

    ReplyDelete
  7. I saw an Advertisement about IDFC Infrastructure Bonds IPO yesterday. Are they a good buy? can you elaborate on it?

    ReplyDelete
  8. @ Chandrasekar

    I will write up a post about these IDFC bonds IPO very soon, Watch out my blog for the same :)

    ReplyDelete

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