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PSU-backed bonds with completely tax-exempt interest income
Tax-free bonds are debt securities issued by government Public Sector Undertakings (PSUs) where the interest income is completely exempt from income tax under Section 10 of the Income Tax Act. This makes them highly attractive for investors in higher tax brackets.
These bonds are typically issued by infrastructure-focused PSUs like NHAI (National Highways Authority of India), REC (Rural Electrification Corporation), PFC (Power Finance Corporation), IRFC (Indian Railway Finance Corporation), and HUDCO (Housing and Urban Development Corporation).
Important Note
No new tax-free bonds have been issued since 2016. These bonds are now only available in the secondary market through stock exchanges.
Understanding what makes tax-free bonds unique
Interest income is completely exempt from income tax under Section 10. No TDS deduction, making it ideal for high-income investors.
Issued by government-backed PSUs like NHAI, REC, PFC, IRFC, and HUDCO. AAA-rated with minimal default risk.
Typical maturity periods of 10-20 years. Original issue dates range from 2012-2016, with varying remaining tenure.
5.5-6% tax-free yield equals 7.8-8.5% pre-tax yield for investors in the 30% tax bracket, making them competitive.
AAA credit rating with sovereign backing. Principal repayment guaranteed at maturity by PSU issuers.
Available on NSE and BSE. Trade in denominations as low as ₹1,000. Prices fluctuate based on interest rate movements.
Tax-free bonds are best suited for specific investor profiles
| Aspect | Details |
|---|---|
Tax on Interest | Completely Tax-Free |
TDS Deduction | No TDS |
Tax Return Filing | Must be Disclosed in ITR |
| Aspect | Details |
|---|---|
Holding Period for LTCG | >12 months (Listed) |
LTCG Tax Rate | 12.5% (without indexation) |
STCG Tax Rate | As per income slab |
| Investment | Gross Yield | Tax (30% bracket) | Post-tax Yield |
|---|---|---|---|
| Tax-Free Bond | 5.5% | ₹0 | 5.5% |
| Fixed Deposit | 7.0% | ₹2,100 | 4.9% |
| Corporate Bond (AAA) | 8.5% | ₹2,550 | 5.95% |
* Calculation based on ₹1,00,000 investment and 30% tax bracket. Tax-free bonds offer better post-tax returns compared to FDs despite lower gross yields.
Understanding the risks helps you make informed investment decisions
Secondary market trading volumes can be low, making it difficult to buy or sell large quantities at desired prices. Exit before maturity may require accepting unfavorable prices.
Bond prices fall when interest rates rise. With 10-20 year maturities, these bonds are highly sensitive to rate changes. A 1% rate increase can lead to 8-12% price decline.
Tax-free bonds often trade at a premium (above face value) in secondary markets. Buying at premium reduces effective yield and may result in capital loss at maturity.
Common questions about Tax-Free Bonds
Tools and guides to help you make better investment decisions
Calculate your effective post-tax returns and compare with taxable bonds and FDs to make informed decisions.
Learn about Government Securities and compare their features, yields, and taxation with tax-free bonds.
Compare post-tax returns between tax-free bonds and fixed deposits across different tax brackets.
Master bond investing fundamentals through our comprehensive structured learning modules.
Use our calculators to determine if tax-free bonds are the right choice for your investment portfolio and tax situation.