Tax-Free Bond: Meaning, Features, Types and Updated Rules

Tax-free bonds are fixed-income investments issued by government-backed organisations, fully exempt from income tax under Section 10(15) of the Income-tax. They provide regular interest payments, and the interest earned is completely exempt from income tax under Section 10(15) of the Income Tax Act.

Key Highlights

• Availability: Only available through the secondary market.
• Taxation: Interest is fully tax-exempt under Section 10(15)(iv)(h).
• Obsolescence: Section 80CCF bonds were discontinued after FY 2011–12.
• Limits: There is no maximum investment limit in the secondary market.
• Pricing: High coupon rates cause these bonds to trade at a premium.

What are Tax-Free Bonds

Tax-free bonds are issued by a government enterprise to raise funds for a particular purpose as a low-risk investment avenue that falls under Section 10 of the Income-tax Act. Tax-free bonds generally have a long-term maturity of ten years or more. The government invests the money collected from these bonds in infrastructure and housing projects.

Features of Tax-Free Bonds

The features of Tax- free Bonds in India are as follows:

• Security: Backed by government-owned entities, offering low default risk and stable tax-free income.
• Income: Provides guaranteed annual tax-free interest along with principal repayment at maturity.
• Taxation: Ideal for high tax-bracket investors as interest income is fully tax-exempt.
• Liquidity: Listed on exchanges but generally have moderate-to-low trading liquidity.

Types of Tax-Free Bonds

The following tables show the different types of Tax- Free Bonds in India: 

Difference between Tax-Free bonds and Tax-Saving Bonds

Both options offer tax benefits, but understanding the key differences between tax-free bonds and tax-saving bonds is important for better financial planning.

How to invest in Tax-Free Bonds

Note: The Government of India has not issued new tax-free bonds in the primary market since 2016. These bonds can now only be purchased from existing investors through the secondary market on the NSE or BSE. Follow the step below to buy Tax- Free Bonds in India:

Step 1: Open or log in to a trading and Demat account with a SEBI-registered broker or OBPP.

Step 2: Search for tax-free bonds on the NSE or BSE using their code or ISIN.

Step 3: Check trading volume, price, residual maturity, and Yield to Maturity (YTM).

Step 4: Place a buy order through your trading platform.

Step 5: Ensure sufficient funds are available in your trading account.

Step 6: After execution, bonds are credited to your Demat account.

Step 7: Monitor your Demat account for annual interest payments credited to your bank account.

Updated Rules for Traded Tax-Free Bonds

Investors buying or selling tax-free bonds on stock exchanges must comply with the tax regulations and operational guidelines prescribed by the CBDT and SEBI.

• Interest Income: Annual coupon payments remain fully tax-exempt under Section 10(15)(iv)(h).
• LTCG Tax: Gains from selling bonds after holding them for more than 12 months are taxed at 12.5% without indexation.
• STCG Tax: Gains from bonds sold within 12 months are taxed according to the investor's applicable income tax slab.
• SEBI Compliance: Investors should trade through SEBI-registered brokers or licensed Online Bond Platform Providers (OBPPs) for secure transactions.

Final Word

Tax-free bonds are ideal for conservative, long-term investors seeking stable, tax-free returns. Before investing, consider market prices, the 12.5% LTCG tax on secondary market sales, and overall trading liquidity.

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