ICICI Safety Bonds November 2000 -- For those seeking tax savings

Recommendations:

Tax Saving Bond: Subscribe

Regular Income Bond: Avoid

Money Multiplier Bond - Option I: Subscribe

Money Multiplier Bond - Other options: Avoid

Suresh Krishnamurthy

THE November 2000 offer of ICICI Safety Bonds has three investment options -- Tax Savings Bonds, Regular Income Bonds and Money Multiplier Bonds.

Tax Savings Bonds: Tax Savings Bonds offer tax rebate under Section 88 of the IT Act. Two factors make these bonds attractive. One, the low term-to-maturity period. Two, these bonds are the only available investment options for availing the extra rebate that investments in infrastructure bonds qualify for.

These bonds have two options -- I and II. Option II is a Deep Discount Bond which, given the prevailing laws on tax deduction at source, appears suitable only for investors in the highest tax bracket. Others can choose this option if the investment is likely to be in only one bond in this financial year. Investment in more than one bond would trigger the TDS requirement at the time of redemption. Option I offers annual interest and the coupon rate is 10.5 per cent.

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The yields in both the options are attractive for an investor seeking tax savings. The yields are the same as that offered in the August 2000 and October 2000 offering. Regular investors in ICICI Tax Saving Bonds may be better-off keeping their investments to the bare minimum to minimise their exposure to ICICI from a portfolio perspective.

Regular Income Bonds: The terms of the Regular Income Bonds are similar to the October 2000 offer. The term-to-maturity is unattractive at five years.

In option I, the yield to an investor who does not re-invest the proceeds does not compare favourably to that offered by the six-year Post-office Monthly Income Scheme. POMIS offers a YTM of 12.84 per cent. In addition, there is no hassle of TDS. Investors seeking monthly income can opt for POMIS instead.

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In option II and III too, the yields for a five-year instrument are more in line with that offered by bank term deposits. In fact, they are higher than that offered by most banks. Still, it may be better to opt for POMIS even if one does not need monthly incomes, and reinvest the monthly proceeds in recurring deposit schemes, since the yield offered by POMIS is substantially higher.

Generally, it is advisable to avoid bonds with a term-to-maturity of five years or more. For exposures to longer-term securities, the government schemes appear more attractive. Exposures can be taken directly, as in the case of small savings or mutual funds, as needed, for investing in gilts. Another option for an investor seeking annual income is option I of the Tax Savings Bond. As indicated earlier, it has a three-year term-to-maturity. The YTM at 10.5 per cent compares favourably to bank term deposits with similar term-to-maturities.

Money Multiplier Bonds: ICICI has come out with five different options. Compared to the October 2000 offer, the terms have been altered slightly to marginally increase the YTM.

In option I, the short term-to-maturity is attractive for an investor with high tax incidence. For those without any tax incidence, an investment in only one bond can be contemplated, since an investment in more than one would attract tax deduction at source.

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In option II, the money doubles in six years and five months. In the case of Kisan Vikas Patra, the money doubles in six years and six months. Option II has a better yield compared to KVP. However, KVP scores on three other counts. Starting from the end of 30 months, an investor in KVP has a put option every six months. If an investor so chooses, the funds can be got back at a lower rate. Besides, there are no TDS hassles. In this backdrop, investors can opt for KVP instead. KVP is also less risky and has virtually no default risk.

In other options too, the disconcerting factor is once again tax deduction. An investor who wants to receive a lakh of rupees after a period of 15 years and invests accordingly would receive 10 per cent less because of tax deduction at source. This is an excellent arrangement for an investor in the tax bracket, who gets to postpone the tax incidence. However, for others with unexhausted Section 80-L limits, it is not so. Retrieving back this sum from the IT Department may indeed take 15 years. But should investors take the risk?

For longer-term investments of 15 or more years, the Public Provident Fund is still the more attractive investment, especially for investors in the tax bracket, since the interest income is wholly tax-exempt. In addition, it is cumulative such as a money multiplier instrument. The only factor is that a minimum investment of Rs 100 needs to be made each year to keep the account alive. Another advantage in the case of PPF is the relative ease with which loans can be obtained.

Note: Despite the fact that in the case of Regular Income Bonds and Money Multiplier Bonds, alternative instruments with superior features exist, there are investors who would opt for these bonds, given the need for portfolio diversification. Such investors would be better-off investing in the dematerialised form. Trading in the dematerialised segment of the secondary market for debentures is likely to take-off sooner than latter. If it does, then holding debentures in the dematerialised form would improve the liquidity of the investments. These investors would also do well to maintain a lower proportion of their total investment in the bonds offered by financial institutions from a portfolio perspective and that too preferably in bonds with a lower term-to-maturity.

Terms and conditions

*Full and firm allotment against all valid applications for the Tax Savings Bond.

*Preference in allotment, up to 70 per cent of the issue size, after allotment of Tax Savings Bond, for applications up to a total of 50 bonds (not including Tax Savings Bond) by individuals, minors and kartas of HUFs.

*Preference in allotment, up to 67 per cent of the balance of the issue size, after allotment of Tax Savings Bond and preferential allotment, as above, for applications by private/public religious/charitable trusts and any other investors requiring approved security status for making investments.

*No early recall of bonds.

*The maximum application size should not exceed Rs 3 crore. However, there is no maximum application size for individuals, HUFs, NRIs, minors and public/private charitable/religious trusts.

*Bonds are to be listed in the Stock Exchange, Mumbai, and the National Stock Exchange.

*The market lot will be one bond.

*Interest on application money will be paid at 4.5 per cent per annum on the amount allotted for the period commencing from the third day after the date of deposit of application form with the bankers to the issue, till a day prior to the deemed date of allotment.

*The CBDT has clarified that for the purposes of Section 88, investors would be allowed to obtain benefit under this Section with respect to the date of application to the extent of allotment made.

*The difference between the issue price and face value of the Money Multiplier Bond in the nature of Deep Discount Bond and Tax Savings Bond option II will be treated as interest income assessable under the Income-Tax Act.

*The interest paid on application money, interest on refund and interest on bonds will be subject to deduction of tax at source at the rates prevailing from time to time under the provisions of the IT Act or any statutory modification or re-enactment thereof.

*The interest paid on application money, interest on refund and interest on bonds will not be deducted at source from interest on application money and from interest on bonds if such interest does not exceed Rs 5,000 and Rs 2,500 respectively in any financial year.