NHAI's tax free bonds - Should you subscribe?

The Central Board for Direct Taxes has allowed 4 firms to raise up to Rs 30,000 cr through the issue of Tax Free bonds in FY12. The National Highways Authority of India (NHAI) and the Indian Railway Finance (IRFC) have each been allowed to raise up to Rs 10,000 cr. The Housing and Urban Development (HUDCO) and Power Finance Corp (PFC) are allowed to raise up to Rs 5,000 cr each through Tax Free bonds. Tax Free bonds means that the interest earned from these bonds is exempt from Income Tax, and is not added while computing the Total Income.

NHAI is an autonomous authority of the Govt. of India under the Ministry of Road Transport and Highways (MoRTH) constituted on Jun 15, 1985. The main objective of NHAI is the development, maintenance and management of the national highways entrusted to it by the govt.

NHAI is tapping the market to raise funds up to Rs 10,000 cr through Tax Free Secured Redeemable Non-Convertible Bonds. The funds raised through this issue will be used to finance various projects of the company. The issue opens on Dec 28, 2011 and closes on Jan 11, 2012. Of the total issue size, 40% is for companies, FIIs, mutual funds etc., 30% is for HNI investors and the remaining 30% is for retail investors. The bond has the highest credit rating of “AAA” from CRISIL, CARE and Fitch, indicating the highest degree of safety and timely servicing of debt obligation. This also tells us that the company has very strong fundamentals.

The minimum application value of the bond is Rs 50,000 (50 bonds), following which investors one can apply in multiples of Rs 1,000 (1 bond). The bonds will be listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). There are 2 options available for investors. Option 1 has a coupon rate of 8.20% p.a. with a tenure of 10 years, while Option 2 has a coupon rate of 8.30% p.a. with a tenure of 15 years. Interest will be paid annually on Oct 1 of every year.

The bond is more attractive to investors which come under higher tax brackets. In case an individual who comes under the highest tax bracket (30.9%) then for Option 1, he gets an effective yield of 11.87% while for Option 2, the yield is 12.01%.

These bonds are unlike tax saving infrastructure bonds, which had a minimum lock in period of 5 years and where the interest was taxable. Even though these bonds will be traded in the market, it should be noted that the volume in the exchanges is quiet low. Hence, liquidity could be one of the problems. Also, these bonds are treated as Long Term Capital Assets if they are held for more than 12 months. Note that there will be no tax deducted at source on interest earned. Hence, individuals should invest in the bond if they have a long-term horizon and do not require funds in the short term.

We, at DSIJ, believe that investing in Option 2 is better, as its effective yield is greater than that in Option 1.