Infrastructure Bond: Confusion over Tax-Saving Vs Tax-Free Bonds makes taxpayers pay more tax than benefit availed

To avail additional deduction up to Rs 20,000 over and above the 80C deductions from his taxable income in the Assessment Year (AY) 2011-12, Koushis Dey (name changed) invested in Long-Term Infrastructure Bonds issued by IDFC Ltd in the Financial Year (FY) 2010-11 as a tax-saving option u/s 80CCF.

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As the cumulative option offered higher return than the non-cumulative option, Koushis invested Rs 20,000 in the cumulative option to get 4 bonds of Rs 5,000 each assuming that the gains on maturity will be tax-free.

As he was in the 10 per cent tax bracket in AY 2011-12, Koushis got a tax benefit of Rs 2,000 (without cess) in that year.

Under the non-cumulative option, interest payout was regular and only the capital invested is returned on maturity, while under the cumulative option, the value per IDFC Bond of Rs 5,000 becomes Rs 10,800 on maturity.

So, the total maturity value of his investment of Rs 20,000 should be Rs 43,200 with the net gain of Rs 23,200. But Koushis got surprised when 7.5 per cent or Rs 1,740 tax was deducted at source (TDS) before he got the maturity value credited in his bank account.

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As he is now in the 30 per cent tax bracket, Koushis now wonders if he needs to pay 22.5 per cent more (excluding cess) on the gain amount of Rs 23,200.

“The interest derived from Long-Term Infrastructure Bonds would be taxable under the head ‘Income from Other Sources’ in the hands of the investor. The deduction u/s 80CCF of the Income Tax Act, 1961 does not pertain to the interest on such bonds,” said Dr. Suresh Surana, founder, RSM India.

“In this context, it is important to note the difference between tax-saving bonds and tax-free bonds. Tax-free bonds refer to such bonds where the interest component on the bonds is exempt from taxation or is tax-free whereas tax-saving bonds are the ones where the principal component is allowed as a deduction to the investor while computing his taxable income. Thus, Infrastructure bonds in question, being tax-saving bonds, the interest on the said bonds would be subjected to taxation,” he explained.

It will result in a total tax liability of Rs 6,960 (excluding cess) on maturity, while he availed tax benefit of Rs 2,000 by investing in the tax-saving long-term infrastructure bonds.

But, why is the TDS rate 7.5 per cent?

“The interest derived from such bonds would be subjected to TDS u/s 193 of the Income Tax Act. Section 193 requires the payer of such interest to deduct TDS @ 10 per cent while making payment of such interest or crediting the account of the payee, whichever is earlier. However, the government has reduced the rate of TDS on specified payments (including those made u/s 193) made to residents on account of the pandemic situation. Such tax rate has been reduced by 25 per cent for the period between May 14, 2020 to March 31, 2021, thus making the applicable TDS rate u/s 193 to be 7.5 per cent,” said Dr. Surana.

Talking on the benefit, Dr. Surana said, “There would be no direct tax advantage accruing to the investor on account of moving from 10 per cent to 30 per cent tax bracket over 10 years.”

However, the tax liability of Koushis under the non-cumulative option would have been lower as the interest payout was regular as he moved gradually from 10 per cent to the 30 per cent tax bracket.

He now rue over selecting the cumulative option due to the confusion that tax-saving bonds are the same as tax-free bonds.

Not only Koushis, the confusion over tax-saving and tax-free bonds has left many taxpayers – who availed tax benefits by investing in Long-Term Infrastructure Bonds issued by IDFC, REC, IIFCL, etc and have moved to higher tax bracket over the 10-year investment period – startled, as tax payout on maturity value under cumulative option exceeds the tax benefit availed on the investment amount.