Tax-free bonds have become a popular tool in the investment circle and steadily gained popularity among long-term investors due to tax benefits. Unlike fixed deposits, the interest earned from NSCs and other bonds are tax free. They offer a good investment opportunity, especially to those who come under higher tax brackets of 20% and above. The other advantages are that they offer tremendous scope for capital appreciation and that one can buy and sell them easily via stock exchanges.
Tax-free bonds issued by the companies usually come with an annual interest payment option. This may not sound extremely pleasing if you wish to receive a monthly income from the investment. However, a few smart steps will help you generate a monthly income from your investment.
Capital gains tax
Under the provisions of Section 2 (29A) of the I-T Act, listed bonds are treated akin to long-term capital asset if they are held for more than 12 months. However, for periods less than 12 months, the bonds are treated as short-term capital, and gains are taxed as per rates in the I-T Act. Additionally, the 2% education cess and the 1% secondary and higher education cess are also applicable while clubbing the gains to the total annual income.
How it works
The first step is to purchase tax-free bonds issued by government-backed firms like HUDCO, PFC and IRFC and stay invested for at least one year. From the 13th month onward, you can start selling bonds worth 1% of your investment per month.
For example, if you come under the 30% tax bracket and have purchased tax-free bonds worth R10 lakh from HUDCO with an investment period of 10 years. Selling bonds worth 1% of your investment every month will give R10,000 every month for eight years and four months.
The monthly amount is available against an investment of R10 lakh for 100 months after the one year, thus helping you avoid the short-term capital gains tax. Thus you stand to gain from the annual tax savings while getting a monthly income at a decent interest rate.
For this scheme to work, certain arrangements have to be made and process followed.
* You need to purchase the bonds via a demat account to enable you to sell a fixed proportion of bonds every month.
* The value of the tax-free bonds should increase exactly equal to the monthly value of their annual interest after each annual interest payment.