IRFC tax free bond: Opportunity to lock into high rates

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Investors who haven’t yet subscribed to tax-free bonds earlier this fiscal have another opportunity to do so. Indian Railway Finance Corporation (IRFC), a financing arm of the Ministry of Railways, is issuing its tax-free secured bonds from January 21 to January 29. It is offering retail investors 7.68 per cent on its 10-year bonds and 7.84 per cent on its 15-year bonds. This is 0.5 percentage points higher than for other investor categories.

IRFC’s bond rates are marginally lower (by 1-2 basis points) than the earlier bond issues of PFC and IIFCL, which enjoyed similar highest credit rating of AAA (indicating highest degree of safety).

But being tax-free, the return on IRFC’s bonds is better than the best after-tax return on bank deposits currently – 6.8 per cent for depositors in the 30 per cent tax slab and 7.82 per cent for those in the 20 per cent tax slab.

Besides, there is a good possibility of the central bank reducing policy rates in its credit policy at the end of this month. This will translate into lower rates on future tax-free bonds, if any, during the rest of this fiscal. It could also mean an improvement in market price for these bonds, which carry higher interest rates. Investors in the higher tax slabs can consider locking into the attractive rates being offered by IRFC’s bonds. Interest on these bonds will be paid out annually.

PRIORITY

But invest in the tax-free bonds after putting money into instruments such as public provident fund (PPF) which offer better tax-free rate (8.8 per cent currently) besides providing tax deduction up to the maximum investment limit of Rs 1 lakh.

That said, retail investors can invest a much larger amount (up to Rs 10 lakh) in IRFC’s tax-free bonds which can also be sold on the BSE and the NSE. But note that capital gains tax will be applicable on gains from sale.

Also, once the bonds originally allotted to retail investors are sold or transferred, the benefit of 0.5 percentage point higher interest is lost. In such cases, the annual rates decline to that offered to other investors (7.18 per cent on the 10-year bonds and 7.34 per cent on the 15-year bonds). Non-resident Indians are also allowed to invest in these bonds, but they can get better returns on NRE fixed deposits with banks that offer rates of around 9 per cent, tax-free.

COMPANY DETAILS

IRFC, fully owned by the Government, finances the acquisition of rolling stock such as locomotives, coaches and wagons ordered by the Ministry of Railways (MoR). The MoR and its related entities are IRFC’s sole clients.

The company leases out the rolling stock to the Indian Railways for long periods on a cost plus margin basis. This helps it earn steady net interest margin of around 0.5 per cent. As on September 2012, IRFC’s long term loans and advances was Rs 59,778 crore, up from Rs 25,301 crore in March 2008.

Government support means that the company has low financial risk. It had zero non performing assets as of September 2012. The company posted a profit of Rs 481 crore during FY-12 and Rs 299 crore for the six months ended September 2012.