We are in the midst of a series of interconnected and mutually reinforcing crises. Some, like COVID-19 and the ensuing recession and huge unemployment, happen out of nowhere, like a cliff fall.
Others, such as droughts, floods, fires, sea level rise, severe storms, and mass extinctions brought on by climate change, are happening slowly, like a frog in a pot, or quickly, like a punch to the gut.
The COVID-19 and climate crises are both exacerbated by the infrastructure problem, which saps our potential to be resilient. Roads, bridges, and tunnels, water and energy infrastructures, mobility and transit projects, levees and sea walls, and communications networks, as well as schools, hospitals, and public and private buildings, are all threats and damage multipliers. Better infrastructure can help mitigate and manage the effects of natural disasters, as well as create jobs and alleviate structural racism and inequality.
The difficulty is that infrastructure has a high sticker price, and we pay for it mostly through taxes and fees. However, due to the COVID shutdown and subsequent recession, there are even fewer taxes and fees available for infrastructure at the local level, creating an unsustainable loop.
The Qualified Infrastructure Bond Program is a key part of the bill that would enable cheaper funding for infrastructure projects around the country (“QIB”). QIBs are taxable municipal bonds in which the federal government pays the municipal issuer a direct interest subsidy rather than tax-exempt interest. This will help keep infrastructure project finance costs low across the country.
The federal government helps to local infrastructure by exempting interest income from taxation on municipal bonds issued by state and local governments for infrastructure. As a result, the bond issuer offers the investor a lower interest rate, or “yield,” and the local government saves money on interest payments. The federal government lowers the cost of municipal infrastructure by eliminating the interest tax.
However, the federal subsidy offered by making interest on municipal bonds tax-exempt has a substantial disadvantage: it only benefits investors who would otherwise pay tax on the interest income. Tax-exempt investors, such as pension funds, university endowments, and private foundations, are normally excluded from paying taxes on interest received on their investments. Similarly, overseas investors who receive interest on U.S. bonds are generally not taxed. Bringing these investors into the muni market would deliver a much-needed infusion of new capital into the United States’ infrastructure.
The Moving Forward Act provides a solution to this problem. It would distribute the federal interest rate subsidies in a different way, allowing a far bigger group of investors to invest in municipal bonds. The initial Build America Bonds program, which was established as part of the financial crisis stimulus bill, the American Recovery and Reinvestment Act of 2009, took this strategy (ARRA). The BAB program allowed towns to issue taxable bonds and receive a direct federal subsidy equal to 35% of the bonds’ interest payments. As a result, the issuer’s net interest expense was 65 percent of the taxable bond rate, which was close to the tax-exempt bond rate.
The BAB initiative was a huge success. Approximately $181 billion in municipal bonds were issued under the program from April 2009 to December 2010, accounting for almost one-third of the issuance of new long-term municipal bonds during that time period. Each of the 50 states as well as the District of Columbia issued 2,275 different bond issues. Treasury calculated that issuers saved about 84 basis points on 30-year bonds and significant savings on shorter maturities, owing to the fact that BABs attracted to a bigger market of investors than traditional tax-exempt bonds because they were taxable.
- Second, it has higher subsidies in the beginning42 percent from 2020 to 2024, then 40 percent from 2024 to 2026, before stabilizing at 30% from 2027. This is critical in light of the current economic downturn.
- Third, if the subsidy is decreased as a result of sequestration, the statute requires that the issuers be made whole (“grossed up”) to compensate for the losses.
However, there is one essential and timely aspect of the new initiative that has been overlooked.
If there’s one thing COVID-19 and climate change have taught us, it’s that not all infrastructure is made equal.
A health-care system that can cope with a spike in cases during a pandemic is preferable to one that can’t.
Teachers and students who have access to high-speed, low-cost internet have a better chance of effectively teaching and learning. Those who don’t most likely don’t.
Extreme heat and cold are too much for poorly built buildings to handle. Communities with unprotected shorelines are vulnerable to deadly storms.
During a pandemic, a bus and subway system that cannot minimize the spread of airborne viruses will be unable to function.
To remedy this, the Moving Forward Act should provide additional incentives for bonds that clearly demonstrate that they are cutting emissions, building resilience, and safeguarding our most vulnerable communities (dubbed “Build Back Better Bonds” or “B4s”). The burgeoning green and sustainable bond market demonstrates that these types of investments are in high demand.
Because these projects create jobs and reduce pollution while saving money, property, and lives, this special treatment would be more than warranted.
Is the interest on infrastructure bonds taxable?
As a result, the tax-advantaged long-term infrastructure bonds were not really tax-free bonds.
The annual interest payout option and the cumulative interest option were both available to the investors.
While investors who chose annual interest distributions have already paid tax on the amount of interest received, those who chose the cumulative option would pay more tax in the year of investment than they saved in the year of investment.
Confusion over Tax-Saving vs. Tax-Paying Infrastructure Bonds
Taxpayers who take advantage of free bonds end up paying more in taxes than they receive in benefits.
Taxation
Because the interest on long-term infrastructure bonds is taxable, the interest earned by the investors annually for those who chose the annual option and aggregate on maturity for those who chose the cumulative option will be added to their taxable income.
As a result, tax payable will be lower for investors in lower tax bands and higher for those in higher tax brackets.
TDS
For Resident taxpayers who choose the cumulative option in physical format, the interest payment will be subject to a 10% Tax Deducted at Source (TDS) if the interest payment upon redemption exceeds Rs 5,000.
The TDS rate will increase to 20% if the bondholder does not have a valid PAN or if the investor has not submitted his tax returns for the last two years and the total TDS and TCS in each of those years is Rs 50,000 or higher.
TDS of 31.2 percent would be applied to interest payouts for non-resident taxpayers.
How to save TDS
Resident bondholders must submit Form 15G / 15H, as appropriate, to avoid TDS. Those who did not disclose their PAN data at the time of investment must update their PANs with the various RTAs within the time frames set by the bond issuers.
Non-Resident bondholders must submit a tax officer’s order under Section 197 / 195 setting NIL / lower TDS rates to the appropriate RTAs before the deadline to guarantee that TDS is collected at the rates provided in the order.
What kinds of bonds are tax-free?
Federal income from state, city, and local government bonds (municipal bonds, or munis) is normally tax-free. However, you must record this income when you file your taxes.
In most cases, municipal bond income is tax-free in the state where the bond was issued. However, take in mind the following:
- Occasionally, a state that normally taxes municipal bond interest would exempt special bonds when they are issued.
Municipal bond income may potentially be free from local taxes, depending on your state’s regulations. For further information on the rules in your state, see a tax advisor.
How much does infrastructure bond interest cost?
The majority of recently issued infrastructure bonds have a coupon (interest rate) of 7.5 percent to 8.25 percent. The IFCI’s second series of bonds, which were just completed, carried a coupon of 8% with a five-year repurchase option and 8.25 percent with no buyback option.
Are bonds exempt from taxes?
Tax-free bonds pay interest that is not subject to income tax. It’s important to remember that selling tax-free bonds on the secondary market will result in capital gains tax. If you sell them within a year of buying them, you’ll have to pay tax on the gains according to your tax bracket.
Is the infrastructure bond issued by IDFC taxable?
The interest on these bonds is not tax deductible. The interest earned by the investor is subject to taxation. The interest on these bonds is classified as income from other sources and is included in the assessee’s total income for the financial year in which it is received.
How do you account for revenue from infrastructure bonds?
Koushis received a tax credit of Rs 2,000 (without cess) in AY 2011-12 since he was in the 10% tax bracket.
The interest was paid on a regular basis and just the capital invested was refunded at maturity under the non-cumulative option, whereas the cumulative option increased the value of each IDFC Bond from Rs 5,000 to Rs 10,800 at maturity.
As a result, the entire maturity value of his Rs 20,000 investment should be Rs 43,200, with a net gain of Rs 23,200. However, Koushis was taken aback when a tax of 7.5 percent, or Rs 1,740, was deducted at source (TDS) before the maturity value was transferred to his bank account.
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Koushis now wonders if he needs to pay 22.5 percent more (excluding cess) on the Rs 23,200 gain now that he is in the 30% tax band.
“In the hands of the investor, interest earned on Long-Term Infrastructure Bonds would be taxable under the heading ‘Income from Other Sources.'” “The interest on such bonds is not eligible for the deduction under section 80CCF of the Income Tax Act, 1961,” said Dr. Suresh Surana, founder of RSM India.
“It’s crucial to understand the distinction between tax-saving bonds and tax-free bonds in this context. Tax-free bonds are those in which the interest component is exempt from taxes or tax-free, whereas tax-saving bonds are those in which the principle component is deducted by the investor when calculating his taxable income. As a result, the interest on the Infrastructure bonds in question, which are tax-free bonds, would be taxed,” he explained.
On maturity, it will result in a total tax burden of Rs 6,960 (excluding cess), whereas he received a tax advantage of Rs 2,000 by investing in tax-saving long-term infrastructure bonds.
“There would be no direct tax advantage accruing to the investor on account of rising from a 10% to a 30% tax band over ten years,” Dr. Surana stated of the benefit.
However, under the non-cumulative option, Koushis’ tax burden would have been lower because the interest payments were consistent as he progressed from the 10% to the 30% tax rate.
He now regrets choosing the cumulative option due to the misunderstanding that tax-saving bonds and tax-free bonds are the same thing.
Not only Koushis, but the ambiguity surrounding tax-saving and tax-free bonds has surprised many taxpayers who have reaped tax benefits by investing in Long-Term Infrastructure Bonds issued by IDFC, REC, IIFCL, and others and have subsequently moved to a higher tax bracket over the 10-year investment period, as the tax payout on maturity value under the cumulative option exceeds the tax benefit reaped on the investment amount.
What bonds aren’t tax-free?
- Municipal bonds are debt securities issued by governments such as states, cities, and counties to assist fund their expenditure needs.
- Munis are appealing to investors because they are not taxed at the federal level and are frequently not taxed at the state level.
- Munis are frequently preferred by investors in high-income tax rates due to the tax benefits.
- If an investor purchases muni bonds from another state, the bond’s interest income may be taxed in the investor’s home state.
- Before adding a municipal bond to your portfolio, it’s a good idea to evaluate the tax implications of each one, as you can be startled by unexpected tax costs on any capital gains.
How are bonds taxed?
The majority of bonds are taxed. Only municipal bonds (bonds issued by local and state governments) are generally tax-exempt, and even then, specific regulations may apply. If you redeem a bond before its maturity date, you must pay tax on both interest and capital gains.
Is the amount of bond maturity taxable?
The interest on tax-free bonds is not taxable, according to the Income Tax Act of 1961. This means that, in addition to capital protection and a fixed annual income, you will not have to pay any tax on the income produced from tax-free bonds.