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How good are infrastructure bonds for saving taxes?

18 Oct 2023

The Finance Minister, Mr. Piyush Goyal, had recently stated that India would require close to $4.5 trillion in the next 10 years bringing Indian infrastructure to Asian levels. Countries like China have invested trillions of dollars in building roads, highways, airports, waterways etc and that has largely been instrumental in helping China grow in the last 30 years. Poor infrastructure puts a huge cost on economic growth and it is estimated that if India could bring infrastructure to Asian levels then the annual rate of GDP would get a boost of 2% per annum. It needs to no reiteration that on a base of $2.6 trillion, that is a lot of growth.

One of the big challenges in developing infrastructure is to create credible means of financing the infrastructure. This calls for a robust debt markets and a variety of innovative debt instruments to finance infrastructure. In the current context, the government does provide options to issue special infrastructure bonds with tax breaks to make them more attractive to investors. So, what exactly are tax-saving infrastructure bonds and what are the benefits of investing in infrastructure bonds? Above all, what are the conditions under which I should invest in infrastructure bonds? Let us look at the 3 key categories of infrastructure bonds that are available currently.

1.  Tax free Infrastructure bonds
These are one of the most popular categories of bonds for financing infrastructure. Companies that are into facilitating infrastructure in India are permitted to issue these tax-free bonds. Typically, companies like Rural Electrification Corporation (REC), National Highways Authority of India (NHAI), and Indian Railway Finance Corporation (IRFC) are among the institutions that are allowed to issue tax-free infrastructure bonds. In case of these bonds the interest paid out on the bonds are entirely tax-free in the hands of the investor. Effectively, it increases your post tax yield. For example, if the tax-free bond is yielding 7% interest, then the actual yield on the bond considering 30.9% tax will be

10.13% {7/(1-0.309)}. That is substantially better than what any bank FD can give you. There is no other tax exemption available on these bonds other than the tax exemption on interest payments. However, such bonds come with a long lock-in period so you must be prepared for the illiquidity.

2.  Capital Gains Exemption Bonds

This is another category of bonds issued by infrastructure companies. These are capital gains exemption bonds where you can reinvest long term capital gains in these bonds. Let us say you bought a property in January 2011 and sold it in May 2018 and made a profit of Rs.40 lakhs. Now there be tax payable on long term gains at 20% after considering the impact of indexation. Is there a way to avoid paying this capital gains tax? The answer is to reinvest the capital gains into Section 54EC bonds that are issued by infrastructure companies like REC and NHAI. When you reinvest the capital gains on your property in these Section 54EC Capital Gains bonds, then your capital gains become entirely tax-free. The only condition is that you have to invest the capital gains within a period of 6 months from the date of the transfer of the capital asset to be eligible for this exemption. The tax saved on capital gains is your added benefit on these Section 54EC bonds, apart from the regular interest that you will receive. These bonds typically carry a coupon interest of 6% and have a lock-in period of 3 years. Please note that the interest earned on these bonds is fully taxable in your hands.

3.  Special category Section 80CCF bonds

Infrastructure bonds were also eligible for exemption under Section 80C in the past but the entire benefit was scrapped about 5 years back. In the Union Budget 2018, the Finance Minister re-introduced the exemption for infrastructure bonds via a separate section called Section 80CCF. This Section 80CCF will give an exemption of Rs.20,000 to the investors in the year during which the money is invested in the bonds. While the Section 80CCF is a sub-section of Section 80C, this exemption of Rs.20,000 is specifically for infrastructure bonds and is over and above the Rs.150,000/- exemption limit that Section 80C offers. These bonds will be subjected to a lock-in period of 5 years and the bond tenure is normally up to 10 years. Again, the exemption is only for the contribution. The interest component will continue to be taxable at your peak rate of tax.

Infrastructure bonds are like hitting two birds with one stone. Firstly, infrastructure projects are able to raise funds for infrastructure at much lower cost. At the same time for the HNI investors, this allows them regular income which is tax free. Even for the taxpayer, this is an additional method of saving on tax payouts!


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