Derive The Best Mileage'

She was amused at my consternation and said, This kind uncle is from Timbuktu. I relaxed. Poonam was a chartered accountant fond of throwing posers at me. Uncle, I want a total after-tax amount of at least Rs 7,000 per month for expenses. Or I will be forced to eat into my capital since I have no other income. I also have to ensure that the base capital also grows faster than the rate of the endemic inflation. This was a new game and I accepted the rules.

She pushed a piece of paper in my hands, saying, When I started to chalk out an investment plan, I found myself in the following quandary. This is what she had written :

 

She continued to lament, Uncle, I cannot save taxes even by using PPF, which you like so much. I need Rs 84,000 and nothing less! But her eyes had a mischievous twinkle. I was nonplussed.

After studying the paper, I said, Poonam, you have committed two small errors. Firstly, you have not taken the concession of Sec. 80L under which, an amount upto Rs 15,000 is exempt, out of which Rs 3,000 is specially meant for income from shares and MFs. Secondly, L&T offers four types of bonds, and the annualised rates are about 17.25 per cent, not 15 per cent.

7-year Regular Return Bonds pay 16.75 per cent six-monthly (= 17.45 per cent annualised) or 17.50 per cent annually (=17.50 per cent annualised). Redemption is in 3 instalments of Rs 800, Rs 800, and Rs 900 at the end of 5, 6 and 7 years respectively, per bond of Rs 2,500.

7-year FD Plus pays on a bond of Rs 2,500 annually Rs 650 for 6 years comprising part interest and the rest principal redemption. The interest is mark up of 4.5 per cent (!) over the SBI rate for term deposits beyond 3 years. Interest is payable on outstanding principal every year. Maximum and minimum rate is 20 and 14 per cent p.a. respectively. The interest for the first year has been fixed at 17.5 per cent. The instalment for the 7th year will be duly adjusted.

6-year Early Gain Bond pays 19 per cent for the initial two years, 17 for the next two years and 15 for the subsequent two years. The average equivalent annualised rate is 17.42 per cent.

11-year Deep Discount Bond is my all-time favourite. Invest Rs 6,100 now and receive Rs 9,000, Rs 10,000 and Rs 11,000 at the end of 9, 10 and 11 years respectively. Or an annualised interest of 17.24 per cent. Early redemption options at the end of 5th and 7th year are available without loss.

Poonam, I do not know which type you want but you should have taken the rate of at least 17.25 per cent. Instead ...

Interrupting me, she said, Instead I have assumed 15 per cent. If I opt for regular income, and choose to get annual interest, I shall earn Rs 1.05 lakh. But then, after paying tax thereon, I fall short for my daily expenses. I will be forced to sell a part of my holdings in the market and may have to sacrifice a little interest. You see, these bonds will be listed at the major stock exchanges. Yes, the company is thinking of appointing market makers and if they succeed the sacrifice may not be heavy. But as a good financial analyst, I am sure you would like me to make a conservative but realistic assumption. Anything more is a bonus. You see, in some cases, the FD-Plus or Early-Gain Bonds may serve a better purpose. But I also like the Deep Discount. I can unload holdings on a monthly basis in the market and ...

Then I understood her strategy. Poonam, this is excellent! You were lamenting that you cannot use PPF to save taxes, but that is not true. If you contribute Rs 60,000 to PPF, you can merrily withdraw that much from the bonds. But all you require is a withdrawal of only Rs 54,000. In fact, your capital will go up by Rs 6,000! Do you realise that?

As soon as I said this, I realised my foolishness. This was the very message she had come to deliver to me.

She continued, I like the Deep Discount better because of the tax benefits. These are company bonds and are therefore not under the umbrella of Sec. 80L. But I could earn the exempt amount through some other source and if I do not have extra funds to do so, who cares? The high rate of returns from these bonds more than counterbalances the exemption under Sec. 80L.

I drew her attention to the fact that she wanted to talk about the tax advantage but has ended up with the disadvantage.

Realising her mistake, she said that she was referring to the long-term capital gains she would be earning by selling these bonds after a holding period of one year.

Ah! At least in this respect, I could score over her. Poonam, you appear to have missed out what L&T has said in this respect. I shall read it out to you.

She cut in, I know that the Central Board of Direct Taxes has given an opinion that the difference between redemption and face value will be treated as interest in the case of Deep Discount Bonds. The same opinion further states that the difference between the sale consideration in the share market and issue price will be treated as capital gains or loss, if the assessee has purchased them by way of investment. So I am positive that I can claim the concessional tax rate of 20 per cent flat after claiming the benefit of cost inflation index. Any objections?

Well, I had none except for one. I pointed out that L&T has offered an early redemption option at the end of three years in the case of Regular Return Bonds whereas for Deep Discount, it was at the end of five and seven years. It also kept with itself the right to opt for early redemption on these days.

Yes, she retorted caustically, I have read the so-called experts putting forth this objection. If the interest rates rise, the investor will opt for early redemption and walk away. But what if it falls?

Should the company be denied the right to opt out? In practice, L&T may exercise this option only in rare situations. It would be incurring at least five per cent launch expenses. Longer the holding period, better the spread. It would not be economical for it to opt out unless interest rates fall drastically by about 4-5 points. Do you foresee such a possibility in three, or even seven, years?

I do not. In fact, the Co-FD rates for NBFCs are already poised to take a quantum leap. No, this objection is largely theoretical.

She then added, Here is a golden opportunity to derive the best mileage from investible funds with the highest degree of safety. CRISIL has given it a triple-A rating. What's more, it is amongst the five top private corporates in India.

She concluded, Uncle, sorry, earlier I have talked about me having only Rs 6 lakh. This does not mean that L&T bonds are not useful if I had Rs 60 lakh. You and I will buy 1,000 bonds each. One day before the record date we shall sell the bonds to each other and send them to the registrars for transfer. This way we shall make the market for each other.

Saying so, she left.