Recently, a deep discounted zero coupon bond of REC is getting launched with YTM of 6.15%.
I understand that it is a AAA-rated bond; however, in the market, there are also G-Sec STRIPS available that provide similar YTM of 6.15% from Government of India
There is a lot of chatter in the market where many HNI will be buying the REC deep discounted bond.
My question is, if G-Sec strips are available in the market with sovereign guarantee, why will HNIs buy REC zero coupon bond when YTM are same across both?
In a rare exception, the Central Board of Direct Taxes (CBDT) allowed REC to issue ZCBs with favorable tax treatment. The gains from these bonds will be taxed as long-term capital gains at maturity, instead of being taxed as interest income annually.
Ajay Manglunia, MD & Head, Investment Grade Group, JM Financial, said: “The REC bond issue got an overwhelming response from investors, with the pricing going below 6.25 per cent…After 2016-17, there has been no issuance of a tax efficient/ tax-free instrument with such (AAA) a rating…So, corporates, large family offices and high networth individuals would have invested in a big way.”
Usually both NCDs and zero coupon bonds are taxed at slabs. But govt is allowing it to be taxed as long term capital gains here. Very weird since there was a recent income tax ruling that stated zero coupon bonds are also to be taxed at slab.
The Mumbai Bench of Income-tax Appellate Tribunal (“ITAT”) in Khushaal C. Thackersey v. Assistant Commissioner of Income-tax[2] held that the premium or surplus received by the taxpayer from the redemption of zero coupon NCDs is interest income and not capital gains as there is mere repayment of the debt and no extinguishment of any rights in capital asset takes place during a transaction, hence, cannot be treated as a transfer of capital asset. In the absence of transfer, the redemption of debentures does not give rise to capital gains.
Thanks for the details. I read the ITAT, and my assumption is that it might be a non-notified ZCB. Nowadays, notified ZCBs like REC are treated as LTCG. Since REC was notified, they had to take permission from CBDT for favourable tax treatment.
My confusion was why someone would go with notified Zero Coupon NCDs when there are G-Sec Strips available at the same YTM rate with a sovereign guarantee. Both notified ZCBs and G-Sec Strips will have same tax treatment of LTCG in longer term.
So that means if I sell G-Sec Strips before maturity (maybe a year before maturity), the entire gain (since it is ZCB) will be LTCG, and if I hold a GSec Strip till maturity, it will be taxed as per the slab?
Investors can optimize their tax liabilities by strategically selling G-SEC STRIPS before maturity. By selling STRIPS before they mature, investors can realize capital gains, which may be taxed at a lower rate if the holding period qualifies for long-term capital gains. This strategy allows investors to benefit from the appreciation of the STRIP’s price while potentially reducing their overall tax burden.
Currently, the Long Term Capital Gain Tax on Listed Bonds is 12.5% after 12 months which means a post-tax return for an investor in a high tax bracket!
I haven’t seen STRIPS trading in the market till now. It is a new concept for me. Have to read more on it.
It depends. Most of these STRIPS are hardly traded. I am assuming you saw on some of these new age “bond platform” that a specific Strip is available at yield of 6.15%.
Problem, is that is just an indicative number, and when you actually want to buy it, it might not be available or only a small quantity would be available. So for an HNI who wants to invest 5-10 crs. buying STRIP may not be feasible option.
Whereas in the REC issue, you can get fairly decent allocation.
Second, most investor do not differentiate between Govt and PSU backed by govt. These bonds finally closed at yield of 6.25%, so a small premium + Tax efficiency is sufficient for most investors.
Again this is just concept. Problem will be what if you don’t find a buyer 1 year before maturity and you end up holding till maturity. This is a risky bet, especially if you have huge holding.
Most of these instruments are pretty illiquid and getting a buyer at right time, who is willing to offer you right price is very slim. Chances are high that you might not find a buyer or you will get bad quote just before maturity (because now buyer is on hook for taxation).
Investing in REC bonds takes care of lot of uncertainty for HNIs