Tax-Free Bonds

What they are

Tax-free bonds answer a simple question for an Indian investor: how do you earn fixed, predictable interest without losing a slice of it to income tax every year? These are long-tenure bonds floated by government-backed bodies such as NHAI, IRFC, PFC, REC, HUDCO and NABARD. The interest they pay is fully exempt from income tax under Section 10(15)(iv)(h), so the coupon you see is the coupon you keep.

That exemption is what makes them appealing to people in the higher tax slabs. For someone paying 30% plus surcharge, a tax-free coupon is worth far more than the same headline rate on a taxable fixed deposit, because there is no annual tax leakage on the interest.

A closed primary market

Here is the catch most investors discover quickly. The government has not issued any new tax-free bonds since around 2016. They were sold in the early 2010s to fund infrastructure, typically with tenures of 10 to 20 years and coupons in the broad range of roughly 6 to 7.5%.

With no fresh issuance, the only way in today is the secondary market on the NSE and BSE, or through bond platforms. Because demand from tax-conscious investors stays high while supply is fixed, these bonds often trade at a premium to face value, which pulls the effective yield below the printed coupon.

What to weigh

Only the interest is tax-free; if you sell a bond above your purchase price before maturity, that gain is still taxable as a capital gain. Liquidity can also be thin, so prices move on relatively small trades.

Still, for a long-horizon, conservative portfolio, these bonds offer something rare: high credit quality from sovereign-linked issuers combined with genuinely tax-free income. Compare the post-tax yield against tax-free bonds before assuming an FD or a debt fund is better.