A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.
Understanding Tax Free Bonds
What are tax-free bonds?
These bonds are mostly issued by government enterprises and pay a fixed coupon rate (interest rate). As the proceeds from the bonds are invested in infrastructure projects, they have a long-term maturity of typically 10, 15 or 20 years.
The income by way of interest on tax-free bonds is fully exempted from income tax. The interest earned from these bonds does not form part of your total income. There is no deduction of tax at source (TDS) from the interest, which accrues to the bondholders. But remember that no tax deduction will be available for the invested amount.
The coupon (interest) rates of tax-free bonds are linked to the prevailing rates of government securities. So these bonds become attractive when the interest rates in the financial system are high.
The interest on these bonds is paid annually and credited directly in the bank account of the investor.
The tax-free bonds get listed and then traded on the stock exchange(s) to offer an exit route to investors. But these bonds might not enjoy high liquidity as they are long-term in nature.
Who should invest?
Tax-free bonds are suitable for investors looking for a steady source of income annually and can afford to lock-in their capital for the long term. (Disclaimer: Investors are advised to make their own assessment before acting on the information.)