IRFC Tax Free Bonds Tranche II – Key Features & Tax Benefits

CA Sandeep Kanoi

IRFC is a dedicated financing arm of the Ministry of  Railways.  Its  sole objective is to raise money from the market to part finance the plan outlay of Indian Railways.  The money so made available is used for acquisition of rolling stock assets and for  meeting other  developmental needs of the Indian Railways.

The borrowing programme of IRFC is guided by the requirements projected by Ministry of Railways.  The company has successfully met the targeted borrowings year after year, through issue of both taxable and tax-free Bonds, term loans from banks/financial institutions and through off shore borrowings.  IRFC also makes use of innovative financial instruments to diversify the debt portfolio and to minimize the cost.  Its contribution to infrastructure build-up in Railways is very significant. Till 31^st March, 2012, Rolling Stock assets – Locomotives, Coaches and Wagons – valued at Rs. 82,447 crore have been added to the asset base of the Indian Railways with funding assistance from IRFC. IRFC’s funding has support technology infusion   in the Railways and has enabled Ministry of Railways to purchase new generation Locomotives from General Motors (USA) alongwith transfer of technology and new generation Coaches from Germany for use in high speed/Shatabdi trains.

IRFC is issuing Tranche II of Tax Free Bonds from 28 Feb 2014 to 07 Mar 2014. Key Features of the issue are as follows :-

• Indian Railway Finance Corporation Ltd is fully owned by the Government of India and is a dedicated financing arm of the Ministry of  Railways.
• Issue Size: proposes to raise Rs. 1,50,000 lakhs with an option to retain oversubscription upto Rs.  1,41,687.85 lakhs aggregating to Rs.  2,91,687.85 lakhs.
• Credit Ratings: AAA by ICRA and CARE, AAA/Stable by CRISIL
• Interest on these Bonds is Tax-Free, no TDS is applicable, Wealth Tax is not levied (Detailed Note is given Below)
• Basis of Allotment : On first come first serve basis

Issue Structure: Issue of Tax free Secured Redeemable Non-convertible bonds

STATEMENT OF TAX BENEFITS

Under the current tax laws, the following possible tax benefits, inter alia, will be available to the Bond Holder. This is not a complete analysis or listing of all potential tax consequences of the subscription, ownership and disposal of the Bond, under the current tax laws presently in force in India. The benefits are given as per the prevailing tax laws and may vary from time to time in accordance with amendments to the law or enactments thereto. The Bond Holder is advised to consider in his own case the tax implications in respect of subscription to the Bond after consulting his tax advisor as alternate views are possible. Interpretation of provisions where under the contents of this statement of tax benefit is formulated may be considered differently by income tax authority, government, tribunals or court. We are not liable to the Bond Holder in any manner for placing reliance upon the contents of this statement of tax benefits.

A. INCOME TAX

1. Interest from Bond do not form part of Total Income.

(a) In exercise of power conferred by item (h) of sub clause (iv) of clause (15) of Section 10 of the Income Tax Act, 1961, the Central Government vide notification no 61/2013/ F.No.178/37/2013-(ITA.I) dated 8th August 2013 authorizes Indian Railway Finance Corporation Ltd. to issue during the Financial year 2013-14, tax free, secured, redeemable, non-convertible bonds of ` 1,000 each for the aggregate amount not exceeding ` 10,00,000 lakhs subject to the other following conditions that –

(i) It shall be mandatory for the subscribers of such bonds to furnish their permanent account number to the issuer.

(ii) The holder of such bonds must register his or her name and holding with the issuer.

(iii) The tenure of the bonds shall be ten, fifteen or twenty years.

(iv) There shall be a ceiling on the coupon rates based on the reference Government security (G-sec) rate;

(v) The reference G-sec rate would be the average of the base yield of G-sec for equivalent maturity reported by Fixed Income Money Market and Derivative Association of India (FIMMDA) on a daily basis (working day) prevailing for two weeks ending on the Friday immediately preceding the filing of the final prospectus with the Exchange or Registrar of Companies (ROC) in case of public issue and the issue opening date in case of private placement.

(vi) The ceiling coupon rate for AAA rated issuers shall be the reference G-sec rate less 55 basis points in case of Retail Individual Investor and reference G-sec less 80 basis points in case of other investor segments, like Qualified Institutional Buyers(QIB’s), Corporates and High Net worth Individuals.

(vii) In case the rating of the issuer entity is AA+, the ceiling rate shall be 10 basis points above the ceiling rate for AAA rated entities as given in the clause (vii).

(viii) In case the rating of the issuer entity is AA or AA-, the ceiling rate shall be 20 basis points above the ceiling rate for AAA rated entities as given in the clause (vii).

(ix) These ceiling rates shall apply for annual payment of interest and in case the schedule of interest payments is altered to semi-annual, the interest rates shall be reduced by 15 basis points;

(x) The higher rate of interest, applicable to retail investors, shall not be available in case the bonds are transferred by Retail investors to non retail investors.

(xi) At least 70% of aggregate amount of bonds shall be raised through public issue. 40% of such public shall be earmarked for retail investors.

(b) Total issue expenses shall not exceed 0.65% of the issue size in case of public issue and in case of private placement, it shall not exceed 0.25% of the issue size.

The issue expense would include all expenses relating to the issue like brokerage, advertisement, printing, registration etc.

(c) Section 10(15)(iv)(h) to be read with Section 14A(1) provides that in computing the total income of a previous year of any person, interest payable by any public sector company in respect of such bonds or debentures and subject to such conditions, including the condition that the holder of such bonds or debentures registers his name and the holding with that company, as the Central Government may, by notification in the Official Gazette, specify in this behalf shall not be included;

Further, as per Section 14 A(1), no deduction shall be allowed in respect of expenditure incurred by the assesse in relation to said interest, being exempt under the Income Tax Act, 1961.

Section 2(36A) of the IT Act defines Public Sector Company as any corporation established by or under any state Central, State, Provincial Act or a Government company as defined section 617 of the Companies Act, 1956.

(d) Accordingly, pursuant to the aforesaid notification, interest from bond will be exempt from income tax.

(e) Since the interest Income on these bonds is exempt, no Tax Deduction at Source is required. However,

interest on application money would be liable for TDS as well as tax as per present tax laws.

2. CAPITAL GAIN

(a) Under section 2 (29A) of the I.T. Act, read with section 2 (42A) of the I.T. Act, a listed Bond is treated as a long term capital asset if the same is held for more than 12 months immediately preceding the date of its transfer.

Under section 112 of the I.T. Act, capital gains arising on the transfer of long term capital assets being listed securities are subject to tax at the rate of 20% of capital gains calculated after reducing indexed cost of acquisition or 10% of capital gains without indexation of the cost of acquisition. The capital gains will be computed by deducting expenditure incurred in connection with such transfer and cost of acquisition/indexed cost of acquisition of the bonds from the sale consideration.

However as per third proviso to section 48 of Income tax act, 1961, benefits of indexation of cost of acquisition under second proviso of section 48 of Income tax Act, 1961 is not available in case of bonds and debenture, except capital indexed bonds. Thus, long term capital gain tax can be considered 10% on listed bonds without indexation.

Securities Transaction Tax (“STT”) is a tax being levied on all transactions in specified securities done on the stock exchanges at rates prescribed by the Central Government from time to time. STT is not applicable on transactions in the Bonds.

In case of an individual or HUF, being a resident, where the total income as reduced by the long term capital gains is below the maximum amount not chargeable to tax i.e. `2,00,000 in case of all individuals, ` 250,000 in case of resident senior citizens and ` 500,000 in case of resident super senior citizens, the long term capital gains shall be reduced by the amount by which the total income as so reduced falls short of the maximum amount which is not chargeable to income-tax and the tax on the balance of such long-term capital gains shall be computed at the rate of ten per cent in accordance with and the proviso to sub-section (1) of section 112 of the I.T. Act read with CBDT Circular 721 dated September 13, 1995.

A 2% education cess and 1% secondary and higher education cess on the total income tax (including surcharge for corporate only) is payable by all categories of tax payers.

(b) Short-term capital gains on the transfer of listed bonds, where bonds are held for a period of not more than 12 months would be taxed at the normal rates of tax in accordance with and subject to the provision of the I.T. Act.

The provisions related to minimum amount not chargeable to tax, surcharge and education cess described at Para 2 (a) above would also apply to such short-term capital gains.

(c) Under Section 54 EC of the I .T. Act and subject to the conditions and to the extent specified therein, long term capital gains arising to the bondholders on transfer of their bonds in the company shall not be  chargeable to tax to the extent such capital gains are invested in certain notified bonds within six months from the date of transfer. If only part of the capital gain is so invested, the exemption shall be proportionately reduced. However, if the said notified bonds are transferred or converted into money within a period of three years from their date of acquisition, the amount of capital gains exempted earlier would become chargeable to tax as long term capital gains in the year in which the bonds are transferred or converted into money. Where the benefit of Section 54 EC of the I.T. Act has been availed of on investments in the notified bonds, a deduction from the income with reference to such cost shall not be allowed under Section 80 C of the I.T. Act. The investment made in the notified bonds by an assessee in any financial year cannot exceed ` 50 lacs.

(d) As per the provisions of section 54F of the Income Tax Act, 1961 and subject to conditions specified therein, any long-term capital gains (not being residential house) arising to Bond Holder who is an individual or Hindu Undivided Family, are exempt from capital gains tax if the entire net sales considerations is utilized, within a period of one year before, or two years after the date of transfer, in purchase of a new residential house, or for construction of residential house within three years from the date of transfer. If part of such net sales consideration is invested within the prescribed period in a residential house, then such gains would be chargeable to tax on a proportionate basis.

Provided that the said Bond Holder should not own more than one residential house at the time of such transfer. If the residential house in which the investment has been made is transferred within a period of three years from the date of its purchase or construction, the amount of capital gains tax exempted earlier would become chargeable to tax as long term capital gains in the year in which such residential house is transferred. Similarly, if the Bond Holder purchases within a period of two years or constructs within a period of three years after the date of transfer of capital asset, another residential house (other than the new residential house referred above), then the original exemption will be taxed as capital gains in the year in which the additional residential house is acquired or constructed.

(e) The income by way of short term capital gains or long term capital gains (not covered under Section 10(38) of the IT Act) realized by FIIs on sale of security in the Company would be taxed at the following rates as per Section 115AD of the I.T. Act.

• Short term capital gains- 30% (plus applicable surcharge and education cess).

• Long term capital gains – 10% without cost indexation (plus applicable surcharge and education cess)

As per section 90(2) of the IT Act, the provision of the IT Act would not prevail over the provision of the tax treaty applicable to the non-resident to the extent such tax treaty provisions are more beneficial to the non resident. Thus, a non resident can opt to be governed by the beneficial provisions of an applicable tax treaty.

(f) Under section 195 of the Income Tax Act, Income Tax shall be deducted from sum payable to non residents on the long term capital gain and short term capital gain arising on sale and purchase of bonds at the rate specified in the Finance Act of the relevant year or the rate or rates of the income tax specified in an agreement entered into by the Central Government under section 90, or an agreement notified by the Central Government under section 90A, as the case may be.

However under section 196D, No deduction of tax shall be made from income arising by way of capital gain to Foreign Institutional Investors.

3. BONDS HELD AS STOCK IN TRADE

In case the Bonds are held as stock in trade, the income on transfer of bonds would be taxed as business income or loss in accordance with and subject to the provisions of the I.T. Act.

4. TAXATION ON GIFT

As per section 56(2) (vii) of the I.T. Act, in case where individual or Hindu undivided Family receives bond from any person on or after 1st October, 2009

A. without any consideration, aggregate fair market value of which exceeds fifty thousand rupees, then the whole of the aggregate fair market value of such bonds/debentures or;

B. for a consideration which is less than the aggregate fair market value of the Bond by an amount exceeding fifty thousand rupees, then the aggregate fair market value of such property as exceeds such consideration;

shall be taxable as the income of the recipient.

Provided further that this clause shall not apply to any sum of money or any property received—

a) from any relative; or

b) on the occasion of the marriage of the individual; or

c) under a will or by way of inheritance; or

d) in contemplation of death of the payer or donor, as the case may be; or

e) from any local authority as defined in the Explanation to clause (20) of section 10; or

f) from any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in clause (23C) of section 10; or g) from any trust or institution registered under section 12AA.

B. WEALTH TAX

Wealth-tax is not levied on investment in bond under section 2(ea) of the Wealth-tax Act, 1957.

C. PROPOSALS MADE IN DIRECT TAXES CODE

The Hon‘ble Finance Minister has presented the Direct Tax Code Bill, 2010 (“DTC Bill”) on August 30, 2010. The DTC Bill is likely to be presented before the Indian Parliament thereafter. Accordingly, it is currently unclear what effect the Direct Tax Code would have on the investors.

(Please Note the above is For the purpose of information only, invest only after referring to the final prospectus which is available on the website of IRFC)