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Tuesday, January 03, 2006

Infrastructre Bonds

Infrastructure Bonds
Some bonds have a special provision that allows the investor to save on tax. These are termed as Tax-Saving Bonds, and are widely used by individual investors as a tax-saving tool. Examples of such bonds are:
a) Infrastructure Bonds under Section 88 of the Income Tax Act, 1961
b) Capital Gains Bonds under Section 54EC of the Income Tax Act, 1961
c) RBI Tax Relief Bonds
What are Tax Saving Infrastructure Bonds?
Infrastructure bonds are available through issues of ICICI and IDBI, brought out in the name of ICICI Safety Bonds and IDBI Flexibonds. These provide tax-saving benefits under Section 88 of the Income Tax Act, 1961, for the investor. You can reduce your tax liability by upto Rs 16,000 per annum For instance, the tax-saving bond from ICICI for the month of July 2001 provides two options: a) Face value of Rs 5,000 for 3 years @ 9.00% interest payable annually.
b) Deep Discount Bonds: Carrying a face value of Rs 6,600, these bonds are available for Rs 5,000, and are issued for 3 years and 4 months, after which they are redeemed at their face value, i.e., Rs 6,600, the difference being the interest you're entitled to. The terms for the IDBI Bonds are similar. According to the July 2001 bond issue from ICICI, the yield to investors (including tax benefits) works out to approximately 18.5 per cent per annum in the first option and approximately 16.7 per cent per annum in the second.
INVESTMENT OBJECTIVES
How suitable are Infrastructure Bonds for an increase in my investment?
Deep Discount Bonds are suitable for an increase in your investment. These bonds, which are sold at a discount on their face value, are redeemed at their face value on maturity of the instrument, the difference being your gain.
Are Infrastructure Bonds suitable for regular income?
Yes, interest on Infrastructure bonds is payable @ 9.0 per cent annually.
To what extent do Infrastructure Bonds protect me against inflation?
Infrastructure bonds do not offer any protection against high inflation since the rate of interest they offer is pre-determined, and is not indexed for inflation.
Can I borrow against Infrastructure Bonds?
Yes, you can borrow against infrastructure bonds by pledging them with a bank. The amount depends on the market value of the bond and the credit quality of the instrument.
RISK CONSIDERATIONS
How assured can I be of getting my full investment back? Although Infrastructure Bonds are considered to be pretty safe, you cannot be assured of getting your full investment back as bonds such as ICICI and IDBI bonds are unsecured instruments. The value of the bond is subject to market forces, if you want to sell them before their maturity. Also, in the rare case of the company issuing the bonds going under, you can not sell the company's assets to recover your investments. Hence, you should check the credit rating of such instruments before taking an investment decision.
How assured is my income?
Since both ICICI and IDBI are considered to be financially healthy institutions, income from bonds issued by these institutions is generally assured.
Are there any risks unique to Infrastructure Bonds?
If the bonds have a Call option, it implies that the issuer has the right to pre-maturely redeem the bonds if it so desires. Thus, look out for this in the offer document carefully. Inflation and interest rate movements are the two significant economic factors that play a vital role in the investment decisions of Infrastructure Bonds.
Are ICICI And IDBI Infrastructure Bonds rated for their credit quality?
Yes, they are. In fact, both ICICI Safety Bonds and IDBI Flexibonds are rated AAA by CARE, CRISIL, and Fitch. This means that both the aforementioned bonds belong to the highest safety category.
BUYING, SELLING, AND HOLDING
How do I buy ICICI And IDBI Infrastructure Bonds?
Both ICICI Safety Bonds and IDBI Flexibonds have regular issues. Application forms can be obtained directly from these institutions or through brokers and intermediaries. Also, IDBI Bonds are listed on the stock exchange, and can be purchased from there too.
What is the minimum investment and the range of investment for ICICI and IDBI Infrastructure Bonds?
Both these bonds can be purchased at Rs 5,000 each. You have to apply for a minimum of 1 bond. There are no upper ceilings imposed upon the purchase of such bonds.
What is the duration of IDBI and ICICI Infrastructure Bonds?
The duration of the ICICI Safety Bonds vary according to the option chosen by the investor. Under the first option (mentioned earlier), the duration of is 3 years; under the second option, the duration is 3 years and 4 months. IDBI FlexiBonds are of similar duration.
Can IDBI and ICICI Infrastructure Bonds be sold in the secondary market?
If listed, bonds can be sold in the secondary debt market. IDBI Bonds are listed on both the BSE and the NSE, and can be sold in the secondary debt market. However, to avail of the tax benefits under Section 88 of the Income Tax Act, 1961, your investment in the bond must hold good for at least 3 years.
What is the liquidity of ICICI and IDBI Bonds?
ICICI offers ''Anytime Facility'' on its Safety Bonds whereby the bonds can be sold back to ICICI directly at the prevailing market price. An investor holding IDBI Bonds can exercise the option of early redemption of the instrument subject to the options available on a specified instrument as spelt out in the offer letter.
How is the market value of an Infrastructure Bond determined?
The market value of a bond is linked to its yield on maturity and the prevailing interest rates. Price of a bond will fall if interest rates rise and vice-versa. If the credit rating of the issuer changes, the market price of such bond may be affected. ICICI provides regular updates on the market value of its various bonds on its Website, http://www.icici.com/.
What is the mode of holding ICICI and IDBI Bonds?
Both ICICI Safety Bonds and IDBI Flexibonds provide investors the option of purchasing and holding the instruments either as physical certificates or in the demat form.
TAX IMPLICATIONS
According to Section 88 of the Income Tax Act, 1961, 20 per cent of the amount invested in Infrastructure Bonds qualifies for tax rebates. For instance, if you buy Rs 40,000 worth of tax-saving bonds, and your tax liability is Rs 10,000, then 20 per cent of Rs 40,000, i.e., Rs 8,000 will be deducted from your tax liability. In that case, instead of paying Rs 10,000, you will now pay Rs 2,000 only to the Income Tax Department. The maximum investment on which you can claim a rebate is Rs 80,000, i.e., maximum rebate allowed is Rs 16,000. If you are an author, playwright, artist, musician, actor, or sportsman, the rebate is calculated at 25 per cent instead of the usual 20 per cent. As per Union Budget 2001, the rebate will be calculated at 30 per cent for salaried individuals whose salary is upto Rs 1,00,000.

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