Tag: tax-free bonds

Is buying bonds on Wint Wealth an attractive proposition?

Personal Finance

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Wint Wealth, an alternative debt asset platform for retail investors, recently launched ‘Wint Bricks Nov21’ – a senior secured bonds issue from U GROW Capital (Ugrow), a non-banking financial company.

The bonds are offering an attractive 10.50 per cent (XIRR) for a little over a two-year tenure. You can invest as little as ₹10,000 which is a small ticket size for bond investments. The return is particularly enticing when seen in the context of the falling interest rates on bank fixed deposits.

But the higher returns obviously come with commensurate risk. Do your homework before you take the plunge. Here, we highlight the key points about this bond issue.

What bonds are on offer

Co-founded in November 2019 by two financial services industry professionals, Wint Wealth (earlier GrowFix) is a fixed income investment platform for retail investors. Excluding the latest offering, Wint Bricks Nov21, the platform has so far offered seven bond issues totalling ₹100 crore.

The latest one, Wint Bricks Nov21 is a ₹50 crore senior secured bond issue from Ugrow, an NBFC focused on lending to small businesses (more details later). These bonds have been bought by Wint Wealth and other wholesale buyers (or warehousing partners, as they are called) from Ugrow in a primary issue and are now being made available for sale to retail investors on the Wint Wealth platform.

The bonds mature in 27 months and are offering a return (XIRR or extended internal rate of return) of 10.50 per cent. Investors will receive monthly interest on the bonds and will be repaid 33 per cent of their principal every 9 months (see table for details). That one doesn’t have to wait until maturity to receive the entire principal is a positive on the risk front.

Though, as part principal repayments are made, the monthly interest income is bound to go down.

Usually investment returns are indicated in the form of CAGR (compound annual growth rate). But, in case of investments involving multiple inflows / outflows (periodic interest and principal repayment in the case of the Ugrow bonds) at different times throughout the investment period, XIRR and not CAGR provides the correct return calculation.

The Ugrow bonds are ‘senior secured’ which essentially means that they are secured by way of collateral (assets) on which the bondholders have exclusive charge. In this case, the Rs. 50 crore issue has been collateralized by ₹62.5 crore worth of property loans. The bonds are rated A (Positive) by Acuite Ratings.

Any individual with a demat account can buy these bonds either on the Wint Wealth platform or directly through their brokerage account. Even when you invest via the platform, the order is still placed through the broker and executed on the exchange. Note that, there is a temporary halt in the sale of these bonds and these are expected to be available for sale from December 1. These bonds are listed on the BSE and the NSE. Investors are not charged for transactions on the platform.

While the returns are enticing and buying the bonds too appears easy, let these not be the deciding factors for investing in them.

Also read: Nuts and bolts of Retail Direct Gilt account

Multiple risks

While the bond issue is backed by adequate collateral, the issue has a relatively low credit rating of A from Acuite Ratings and calls for caution. The highest-rated safest bonds are assigned a AAA rating.

Ugrow is a relatively new NBFC specializing in SME lending that began loan disbursements only in January 2019. It had assets under management of only ₹1,933 crore as of September 2021. Sector-wise, light engineering and food processing alone account for 40 per cent of its loan book. While the company’s net NPA (non-performing assets) of 1.8 per cent appears low, this is likely reflecting the impact of loan restructuring (7.2 per cent of its portfolio) undertaken by it in the September 2021 quarter.

When it comes to the collateral, what matters is how liquid it is. In this case, the issue is backed by Ugrow’s property loans. As long as the majority of the borrowers keep servicing their loans, the collateral (property loans) can offer support in the event of any default on the bonds. But, if there were to be a spike in loan defaults, then even though the underlying property can be confiscated, liquidating it to pay off the bondholders can turn out to be a time-consuming process.

Also, while it may be easy to buy the Ugrow bonds now, selling them before maturity may not so, due to lack of sufficient buyers. So, one must be prepared to hold these bonds until maturity.

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All you wanted to know about 54EC bonds

Personal Finance

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A popular option for saving long-term capital gains tax on sale of property is section 54EC bonds. Investing in these bonds can help you make gains of up to ₹50 lakh per financial year from capital gains tax. However, there is a lock-in period of five years. This used to be three years earlier. These bonds carry interest, which is currently at 5 per cent and is taxable.

While these bonds are effective in saving tax, there is another option to consider. You have two choices: (a) save long-term capital gains tax by investing in 54EC bonds and lock in your money for five years or (b) pay the tax, keep your money liquid, and invest it in avenues yielding higher than 5 per cent.

Let us compare the returns from these two options.

Assume, for instance, that there is long-term capital gains of ₹50 lakh that is taxable, after indexation benefit as applicable. A sum of ₹50 lakh invested in 54EC bonds would fetch a defined return of 5 per cent per year. This coupon/interest is taxable at, say, 30 per cent (your marginal slab rate), ignoring surcharge and cess for simplicity. Hence your return, net of tax, is approximately 3.5 per cent. As against this, if you go for option (b), you pay tax on capital gains, which is taxable at 20 per cent if we ignore surcharge and cess, for simplicity. Subsequent to paying the tax of ₹10 lakh, what remains with you for investment is ₹40 lakh. Let us now look at a few options for investing ₹40 lakh.

Tax-free PSU bonds

Since there are no fresh issuances of tax-free PSU bonds and interest rates have eased, the yields available in the secondary market are lower than earlier. For our comparison, we assume a yield (i.e. annualised return) of 4.25 per cent for investing in tax-free PSU bonds. ₹50 lakh invested in 54EC bonds, compounding at approximately 3.5 per cent per year, grows to ₹59.38 lakh after five years. ₹40 lakh, which is the net amount that remains in case of option (b), invested at 4.25 per cent tax-free, grows to ₹49.25 lakh after five years. Hence, investing in 54EC bonds at 5 per cent (pre-tax) is a better option than paying the LTCG tax and investing the remaining amount.

Bank AT1 perpetual bonds

There is a negative perception about perpetual bonds after the YES Bank fiasco. The risk factors that got highlighted after the YES Bank AT1 write-off have always existed, but came into action and hit investors. Having said that, there are front line banks such as SBI, HDFC Bank and the like that are worth investing in.

The range of yields in bank AT1 perpetual bonds is wide. We assume 7.5 per cent to strike a balance between risk (higher yield but higher risk) and reward (lower yield but lower risk). Taxation at 30 per cent means a net return of approximately 5.25 per cent. Against ₹59.38 lakh in case of 54EC bonds, ₹40 lakh invested at 5.25 per cent grows to ₹51.6 lakh after five years. Though somewhat higher than the ₹49.25 lakh from tax-free bonds, this is lower than the ₹59 lakh from 54EC, bonds making the latter a better option.

Equity

It is not fair to compare investments in bonds with equity. However, to get a perspective we will do a comparison. We will talk of the break-even rate now. Let us say, equity gives X per cent return over five years, and that is taxable at 10 per cent, which is the LTCG rate for equity for a holding period of more than one year. If ₹40 lakh invested in equity yields a return of 9.15 per cent per year pre-tax, which is 8.24 per cent net of tax per year, it grows to ₹59.4 lakh after five years. Hence the break-even rate for ₹40 lakh to outperform ₹50 lakh over five years, at 3.5 per cent net of tax, is 8.24 per cent net of tax.

Conclusion

Equity returns are non-defined and the break-even rate calculated for this asset class to outperform 54EC bonds is 8.24 per cent net of tax. It is difficult for bonds as it will be possible only for a bond with inferior credit quality against a AAA rated PSU one. Equity or a riskier bond not being a fair comparison, it is advisable to save the tax and settle for 5 per cent by investing in 54EC bonds. However, liquidity is one aspect you may keep in mind — investment in 54EC bonds is locked in for five years.

The author is a corporate trainer (debt markets) and author

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Tax-free vs tax-saving instruments – The Hindu BusinessLine

Personal Finance

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A coffee time conversation between two colleagues leads to an interesting explainer on tax jargons.

Tina: Have you filed your investment proofs for FY21 yet? The deadline set by the HR team is just around the corner.

Vina: No, I am yet to invest in tax-free instruments for this year.

Tina: What? You mean tax- saving instruments?

Vina: Yeah potato, po-tah-toh! Aren’t they the same thing said differently?

Tina: No. While both tax-free and tax-saving instruments ultimately help in lowering your tax outgo, they aren’t the same.

Vina: Why? What is the difference?

Tina: If you want to save tax on interest or any other incomefrom your investments, you should be investing in a tax-free instrument.

Tax-free bonds issued by State-owned companies such as PFC, NHAI, HUDCO and REC, with a maturity of 10 years or more, are one such example.

You can buy these bonds either during their primary issue or from the secondary market once they get listed.

The existing issues of these bonds currently pay interest rates in the range of 7.6 to 9.0 per cent per annum for varying maturities, and the entire interest income is exempt from tax. Hence, the term ‘tax-free’.

Vina: Oh cool! But in this case, my tax savings are limited only to the extra interest income that I pocket by not having to pay any tax on it, right?

Tina: Yes! If you want to save tax on your existing income, like in your case, you should opt for investing in tax-saving instruments.

Say, your income comes to ₹5 lakh a year. You can invest in certain instruments specified under Section 80C of the Income Tax Act and claim deduction of up to ₹1.5 lakh a year. These include five-year term deposits with banks or the Post Office, deposits in Sukanya Samriddhi Account, contribution to the Public Provident Fund and subscriptions to certain notified NABARD bonds. .

Since investing in these instruments reduces your taxable income and so your tax liability, these are labelled as “tax-saving”.

Remember that income from these tax-saving instruments may or may not be exempt from tax.

Vina: All right, now I get it. They aren’t same at all.

Tina: Yes. Tax-saving instruments help reduce your overall income that is subject to tax, to the extent of investment made. On the other hand, tax-free instruments help you only save tax on the interest income from such instruments.

Vina: Wow, that’s simply put!

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Why tax-free bonds are a good alternative to bank FDs

Personal Finance

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With interest rates at historic lows today, investors looking for better-return, fixed-income options can consider tax-free bonds available in the secondary market. These bonds can be a relatively low-risk alternative to many bank fixed deposits for those in the higher tax brackets.

Tax-free bonds

Tax-free bonds are issued by public sector undertakings such as NHAI, HUDCO, PFC, REC, IRFC, with maturities of 10 years or longer. The last primary bond issue was in March 2016. You can buy these bonds from the secondary market. They are listed on the BSE and the NSE.

‘Tax-free’ here refers only to the tax-free interest. That is, you don’t have to pay any tax on the interest (coupon) received on these bonds. These bonds are not included under Section 80C (Income Tax Act) investments and the money invested in them is not eligible for deduction from your taxable income. The interest on such bonds (paid out periodically) is tax-exempt while that on fixed deposits is taxed at your income tax slab rate.

Note though that while tax-free bonds from certain issuers may enjoy good trading volumes, if you have large bond holdings (of say a few crores of rupees), you may need a few days to a week to exit your holdings completely. “Monitoring of price (and hence yield) and volume of past 1-2 months is required before investing,” says Deepak Jasani, Head of Retail Research, HDFC securities. Liquidity may, however, be less of a concern for those with smaller investments.

 

What bonds to choose

Given the current interest rates, further rate cuts don’t appear likely. To avoid missing out on higher returns once the rate cycle starts turning up gradually, you can invest in tax-free bonds (that have good trading volumes) with a residual maturity of around two years that offer the best yield-to-maturity (YTM). Also, it’s best to stick to AAA-rated bonds (a few are rated below AAA) as they come with the highest degree of safety.

Data from HDFC securities show that AAA-rated IIFCL bonds (series -719IIFCL23) priced at ₹1,114 per bond, with a residual maturity of 2.2 years and daily average trading volumes of 2,557, offer a YTM of 4.71 per cent. The YTM shows your return from a bond if you hold it until maturity.

Do note that YTM calculations assume that interest from a bond is getting reinvested at the same current yield. Tax-free bonds make periodic interest payouts to investors. So, depending on the rate at which these are reinvested, your actual return can be lower / higher than the YTM. For a bond with a relatively shorter residual maturity such as two years, this impact may, however, be very small.

If you sell the bond before maturity, your final return will also depend on the selling price versus the purchase price of the bond. This could result in a capital gain or loss for you – which is the interest rate risk.

Risk return trade-off

While tax-free bonds may not carry as low a risk as many bank fixed deposits do, the AAA-rated bonds do offer a good degree of safety. Unlike bonds, fixed deposits carry no interest rate risk – that is, the value of the original investment remains unchanged. Also, while tax-free bonds may not be perfectly liquid (for large holdings), fixed deposits can be liquidated any time, though subject to a penalty in many cases.

That said, tax-free bonds are issued by public sector undertakings that enjoy Government of India backing. So, they carry low risk of default and can be considered safe.

Who should invest

Investors who are not completely risk averse and are in the 30 per cent tax bracket, can invest in the IIFCL tax-free bonds as an alternative to many public and private sector bank, and small finance bank FDs that are offering lower post-tax returns (see table). Those in the 20 per cent tax bracket, can invest in the bonds as an alternative to some lower-interest rate offering of public and private sector bank FDs.

You can buy and sell tax-free bonds through your demat account. Sale of tax-free bonds attracts capital gains tax. If you sell the bonds within 12 months from the date of purchase, you are taxed on the gains based on your income-tax slab rate. If the bonds are sold after 12 months, the gains are taxed at 10 per cent without indexation benefit or at 20 per cent with indexation benefit.

Floating rate bonds

Another safe investment option for those wanting to diversify from bank FDs are the Floating Rate Savings Bonds 2020 issued by the Central government.

These bonds make semi-annual interest payments which are taxed as per your slab rate, and can be bought from some of the leading banks. The current interest rate on them is 7.15 per cent and is payable in January 2021. The interest rate is reset every six months. These bonds look attractive given that interest rates are expected to gradually move up. The only negative here is the long lock-in period of seven years.

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For conservative investors and retirees, tax-free bonds are a good bet

Personal Finance

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Over the past year or so, many banks have slashed interest rates on the fixed deposits (FDs) they offer, due to the successive repo rate cuts by the Reserve Bank of India (RBI). For instance, State Bank of India (SBI) now offers just 4.9 per cent for 1 year to less than 2 years tenure, and 5.4 per cent for tenures of 5 years up to 10 years.

Also, over the past few years, credit quality issues in debt instruments such as rating downgrades and default in repayments have given trouble to many fixed income investors. Such credit events led to a sharp erosion in the value of the investment products that held these distressed assets in their portfolio. So, capital safety has now become a prime concern for many retail investors.

Given the low interest rate regime, investors looking for debt instruments that provide returns relatively higher than bank FD returns, and also capital safety can consider tax-free bonds available in the secondary market.

Conservative investors and also retirees in the highest tax bracket looking for a regular income on a yearly basis can consider buying these bonds from the secondary market.

 

A total of 193 series of tax-free bonds issued by 14 infrastructure finance companies from FY12 to FY16 are listed on the bourses. They are traded in the cash segment on the BSE and the NSE. These tax-free bonds were issued by public sector undertakings and public financial institutions that are backed by the government of India. Hence, the investments made in these tax-free bonds enjoy capital safety.

Further, the bonds issued by most of these companies have the highest credit rating of AAA. Instruments rated AAA are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry the lowest credit risk.

Attractive yields

Data compiled by HDFC Securities show that there are a handful of tax-free bonds with good credit rating that trade with relatively higher volumes and also offer reasonable yield to maturity (YTM) in the secondary market (see table). These include the series of PFC, NABARD, HUDCO and NHAI bonds.

 

For instance, the NHAI NR series (ISIN INE906B07EJ8), with a coupon rate of 7.6 per cent and residual maturity of 10.3 years, trade with a YTM of 4.8 per cent on the NSE. Since the interest paid by tax-free bonds are exempt from income-tax, the current yield of 4.8 per cent translates to 6.9 per cent pre-tax yield for investors in the 30 per cent bracket. This rate is higher than those offered by most bank FDs currently.

Both the BSE and the NSE facilitate the purchase and sale of tax-free bonds. These are listed and traded in the cash segment along with equity shares. Retail investors can buy and sell tax-free bonds through demat accounts.

While investing in tax-free bonds through the secondary market, investors should not just look at the coupon rate and the market price of the bonds. There are three parameters that they should consider — credit rating, YTM and liquidity.

YTM is the internal rate of return earned by an investor who buys the bond today at the market price, assuming that the bond is held until maturity, and that all coupon and principal payments are made on schedule.

HDFC Securities data shows that around 15 series of tax-free bonds were traded with YTM ranging from 4.4 per cent to 4.9 per cent and good daily average trade volumes over the last one month (see table).

Keep in mind that selling tax-free bonds in the secondary market attracts capital gains tax. If you sell them within 12 months from the date of purchase, you will have to pay tax on the gains as per your tax slab. If you sell after 12 months, tax has to be paid at flat rate of 10 per cent; no indexation benefit is available.

Factors to consider

Take into account the credit rating, YTM and liquidity of the tax-free bonds trading in the secondary market

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