Tax Saving Bonds vs. Tax Free Bonds

A bond, in simple terms is a document which promises the holder certain rewards and benefits in return for an investment. It consists of an Issuer, the agency which provides these bonds and an owner, the person under whose name such bonds exists.

Tax Saving Bonds, as the name indicates are bonds which help people save tax. These bonds offer certain special tax benefits to owners, helping them save a certain portion of their overall tax. Individuals can purchase these bonds and earn a certain interest on them, with a special provision in the Income Tax Act providing tax benefits on investments. Tax Saving Bonds come with a minimum lock-in period of 5 years, making them mid to long term investment tools.

While not as attractive as other investment options, tax savings bonds offer decent returns minus the risk which is generally associated with other instruments, making them ideal for members of the society who wish to save money without risking it. Individuals who are looking for long term returns rather than immediate ones can opt for tax saving bonds.

Some of the popular tax saving bonds are mentioned below:

1. Bonds that come with a Call and Put Option: Under the Call option, the bond can be purchased back by the issuer by paying the principal amount. Under the Put option, you can exit from the bond before maturity and get back the principal amount.
2. Zero Coupon Bonds: Interest will not be paid on such bonds and they will be provided at a lower price. You will receive the face value when the bond matures.
3. Sovereign Gold Bonds: These bonds are provided in gold. The denomination is in grams. Instead of buying physical gold, investors can purchase such bonds.
4. Floating Rate Bonds: Under such bonds, the interest rates will change.
5. Fixed Rate Bonds: Under such bonds, the interest rates will be altered after 6 months. Every 6 months, the investor will receive a payout.

Key Features of Tax Savings Bonds

The main features of tax savings bonds are mentioned below:

1. Once the bonds have been redeemed, capital gains must be paid.
2. Depending on the tax slab, the interest that must be paid will vary.
3. Tax deductions can be claimed.
4. The bonds come with a lock-in period of five years.
5. Rs.1,000 is the minimum investment that must be made.
6. Non-cumulative or cumulative interest payout can be chosen.
7. The rate of interest that will be paid will range between 6% p.a. and 8% p.a.

Differences between Tax Saving Bonds & Tax Free Bonds

Apart from Tax Saving Bonds, another popular alternative is Tax Free Bonds, which in essence are bonds which are tax free. It is possible for the uninitiated to get confused between these two, but there are a few differences which set them apart.

Eligibility Criteria

The eligibility criteria that must be met to invest in such bonds are mentioned below:

1. Indian citizens can purchase such bonds.
2. Hindu Undivided Families (HUFs)
3. Charitable Institutions that are part of the Indian Companies Act of 1956’s 25th Section.
4. Certificate of Registration has been provided to an institution stating that it’s a charitable institution.

Section 80CCF

Tax saving bonds enjoy special privileges under Section 80CCF of the Income Tax Act which states that individuals enjoy tax deductions up to Rs 20,000 on the bonds owned by them. This means that an investor in these bonds can reduce his taxable income by Rs 20,000 in a year, thereby saving on the overall tax he/she might have otherwise had to pay. This deduction is excluding the Rs 1.5 lakh provided under Section 80C of the Act.

Example:

Mr. Kumar, aged 35 has an annual income of Rs 4.8 lakh, putting him in the 10% income tax slab. To reduce the impact of tax and to have an investment for the future, he decided to purchase tax saving bonds from a local bank.

He purchases bonds worth Rs 40,000 with a lock in period of 5 years. Mr. Kumar is now eligible for a tax deduction of Rs 20,000 under Section 80CCF of the Income Tax Act.

As there are no other investments which are eligible for deduction, his taxable income becomes Rs (2.3 lakh minus Rs 20,000), i.e., Rs 2.1 lakh. This reduction helps him save considerable amounts on tax every year he invests in bonds.