Tax-Free Bonds in India: A Smart Investment Choice for Tax Benefits

With numerous investment opportunities available today, it’s essential to consider options that not only offer financial security but also provide tax benefits. Tax-free bonds, issued by public undertakings, offer investors the opportunity to earn a predetermined annual interest while enjoying the advantage of tax-free returns. This article delves into everything you need to know about these bonds, from their meaning to who should invest and how they work.

What are Tax-Free Bonds?

Tax-free bonds are fixed-income securities issued by public undertakings. They provide investors with a chance to earn regular, tax-exempted interest payments, making them an attractive and secure investment option. These bonds are known for their safety and reliability, with the principal amount repaid upon maturity.

There are typically two types of tax-free bonds to choose from. While tax-free bonds offer tax-exempted interest, tax-saving bonds provide initial investment exemptions and may offer lower interest payments.

Investing in tax-free bonds offers several advantages, including:

  1. Tax-Free Interest: Interest payouts are tax-free, providing an additional source of income without the burden of taxation.
  2. Flexible Tenure: These bonds come with investment tenures ranging from 10 to 20 years, accommodating various financial goals and requirements.
  3. Trading Opportunities: Tax-free bonds can be traded in the secondary market, allowing investors to take advantage of market rates. However, profits from such transactions are subject to taxation as per the Income Tax Act.
  4. Choice of Holding: You can hold tax-free bonds either in physical or dematerialized form, depending on your preference.

Advantages of Tax-Free Bonds

Aside from tax benefits, tax-free bonds offer several other advantages:

  1. Regular Income: Investors can count on a consistent annual income, in addition to the principal amount returned upon maturity.
  2. Safety: Being issued by public undertakings or the government, these bonds carry a relatively low risk of default.
  3. Ease of Trading: Tax-free bonds are listed on stock exchanges, making them easily tradable when market rates are favorable.
  4. Higher Returns for High Tax Brackets: Investors in higher tax brackets, such as the 30% or above bracket, can benefit from higher returns. There are no upper limits on investments, allowing for increased tax benefits.

Who is Eligible to Invest in Tax-Free Bonds?

Tax-free bonds are ideally suited for individuals with a low-risk appetite or those seeking security in their investments. Since these bonds are issued by the government or reputable companies, the associated risks are relatively low. Additionally, they are suitable for individuals with longer investment horizons. It’s essential to assess your financial needs and liquidity requirements before investing in tax-free bonds.

Features of Tax-Free Bonds

Here are the key features of tax-free bonds:

  • Tax-Exemption: Interest income is entirely tax-exempt, and tax deducted at source (TDS) does not apply to these bonds.
  • Liquidity: While not as liquid as debt mutual funds, tax-free bonds can be purchased from the secondary market to meet short-term financial goals.
  • Lock-in Tenure: Tax-free bonds come with lock-in periods ranging from 10 to 20 years, and premature withdrawal is not allowed.
  • Returns: Returns depend on the purchase price and current government securities rates, with interest typically ranging between 5.50% to 6.50%.

Commonly Found Tax-Free Bonds

Many public sector undertakings issue tax-free bonds, including National Highway Authority of India, NTPC Limited, Indian Railways, and Rural Electrification Corporation, among others.

Difference between Tax-Free Bonds and Tax-Saving Bonds

Tax-Saving Bonds vs. Tax-Free Bonds

Tax-Saving Bonds:

Tax-saving bonds are a type of investment that offers tax benefits under Section 80CCF of the Income Tax Act in India. These bonds are typically issued by government entities or financial institutions with the aim of raising funds for specific infrastructure projects or development activities. Investors who purchase tax-saving bonds can enjoy tax deductions on the amount invested, reducing their taxable income. However, the interest earned on these bonds is taxable.


Let’s say you invest ₹10,000 in tax-saving bonds, and you fall under the 20% income tax bracket. You can claim a deduction of ₹2,000 (20% of ₹10,000) from your taxable income. However, the interest income you earn on these bonds is added to your total income and taxed accordingly.

Tax-Free Bonds:

Tax-free bonds, on the other hand, are issued by government-backed entities, and the interest income they generate is entirely exempt from income tax. These bonds are typically offered for longer tenures and can be an attractive option for investors seeking tax-free returns.


If you invest in tax-free bonds and earn an annual interest of ₹5,000, you don’t need to pay any income tax on this interest income. It’s completely tax-free, making it a popular choice among investors looking to minimize their tax liabilities.

AspectTax-Saving BondsTax-Free Bonds
Tax BenefitsOffers tax deductions on the invested amount under Section 80CCFProvides tax-free interest income
Tax on Interest IncomeInterest income is taxable and added to taxable incomeInterest income is entirely tax-free
Investment TenureGenerally medium to long-termTypically long-term
LiquidityMay have lock-in periodsGenerally more liquid
RiskLow to moderate risk dependingLow risk
Table: Tax-Saving Bonds vs. Tax-Free Bonds

How to Invest in Tax-Free Bonds

Investing in tax-free bonds is straightforward, with options to trade through a Demat account or in physical form. Subscription periods for these investments are typically limited, so prompt action is essential.

For physical investments, provide your PAN details and complete the KYC process. Bonds can be subscribed online or offline when the government issues them to the public. Post-issuance, trading accounts are used for investments, much like trading shares in the stock market.

In conclusion, tax-free bonds offer a secure investment avenue with tax benefits, making them an attractive choice for a range of investors, including those in higher tax brackets. Understanding their features, benefits, and how to invest in them is essential for making informed financial decisions

FAQs| Tax-Free Bonds

Are there any tax-free bonds available?

Yes, there are tax-free bonds available in India, issued by government-backed entities like NHAI, IRFC, PFC, REC, and HUDCO. They offer tax-exempt interest income under Section 10(15) of the Income Tax Act.

Is RBI tax-free bonds available?

No, RBI does not issue tax-free bonds. It deals with other types of taxable bonds like treasury bills and government securities.

What is an example of a tax-free bond?

An example is the NHAI 7.69% 2031 bond with tax-free interest, issued in 2016. It’s listed on BSE and NSE, with a credit rating of AAA by CRISIL and ICRA.

Which investment is 100% tax-free?

None are 100% tax-free in India. Some offer partial or complete tax exemptions on interest income or capital gains, e.g., PPF, ELSS, SSY, and tax-free bonds.

Is it good to invest in tax-free bonds?

Investing in tax-free bonds can provide tax-exempt income and safety, but consider liquidity, maturity, and risk factors, aligning with your financial goals.

Is interest on tax saver bonds taxable?

Yes, interest on tax saver bonds is taxable. Bonds like NSC, KVP, and Infrastructure Bonds offer deductions under Section 80C, but interest income is taxed based on your income slab.

How much interest income from tax saving bonds?

Interest income varies with the bond type and rate. For instance, NSC offers 6.8% compounded annually for 5 years, while KVP provides 6.9% compounded annually for 10 years.

Is there TDS on NCD interest?

Yes, TDS applies to NCD interest in India. The rate is 10% with PAN details and 20% without PAN, applicable if the interest exceeds ₹5,000 in a financial year.


Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.