Sandeep Shanbhag

For the Indian financial markets, May 31, 2008 would be the end of an era, for that’s when the Unit Trust of India’s (UTI) US-64 scheme (currently in the form of 6.75% tax-free bonds) draws to an end.

Communication in this regard has already been sent by UTI to all bond investors.

For those holding 200 bonds or less, surrendering the certificates is not required. For others, the bond certificates will have to be returned to UTI before May 25, 2008.

Back in July 2001, UTI, beleaguered by US-64’s poor performance, had to take the extreme step of suspending all redemptions from the scheme for a period of six months. For investors used to looking upon US-64 as a government assured social contract, this was a shocking turn.

Eventually, the government did come out with a rescue package wherein between August 2001 and May 2003, investors were allowed to redeem up to 5,000 units at a price band of Rs 10-12, while US-64 units that remained unredeemed were converted into US-64 bonds offering a tax-free interest of 6.75% per annum.

These bonds, which had a tenure of five years, mature at the end of May 2008.

The all-important question now is, where do the US-64 investors redeploy the maturity proceeds? The following options could be considered.

Public Provident Fund (PPF) As we all know too well, there is no avenue that offers a tax-free interest any more, except, of course, the PPF. So, one of the best courses of action, if it is available, is to divert the bond proceeds to PPF. This would mean substituting a 6.75% tax-free investment with an 8% tax-free one.

But, of course, this option may be taken only if it is available. After all, PPF has an upper limit of Rs 70,000 per annum and some investors may well have used up that limit.

Such investors can, of course, invest in the names of any of their family members. As per Sec. 56 of the Income Tax Act, gifts made to close relatives are tax-free and hence such an investment would enable the entire family to earn tax-free interest.

However, the tax deduction offered by PPF is only available for investments made in the name of spouse and children, not for any other family member.

But, the main object here is not the tax deduction but the opportunity to earn higher tax-free interest. Also, most investors are under the impression that PPF means a 15-year lock-in.

This is not so. From the seventh year on, 50% of the balance in the account four years back may be withdrawn. To conclude, if the idea is to invest in a safe avenue over the long term with excellent tax-efficiency and reasonable liquidity, look no further than the PPF.

National Savings Certificate (NSC) Yet another option is the NSC. Discussed in detail last week, NSCs score over PPF in that there is no upper limit for investment. So, if your US-64 bond investment is substantial or investing in someone else’s name is not really your cup of tea, do consider NSCs. Being a six-year cumulative scheme, the interest for the first five years is deemed to be reinvested and hence qualifies for deduction under Sec 80C.

If you have room left in Sec 80C, this would mean that the NSC would earn you tax-free interest for the first five years. The rate is 8.16% and hence, this would mean shifting to a higher tax-free investment. Senior Citizens Savings Scheme (SCSS) Senior citizen investors, especially those not having any taxable income, should directly opt for the SCSS. It offers 9% per annum and the recent Budget has increased the basic taxfree exemption limit for seniors to Rs 2.25 lakh.

In other words, even if you were to invest the maximum Rs 15 lakh allowed under SCSS, @9%, the interest would work out Rs 1.35 lakh, which is much lower than the enhanced basic exemption limit.

Fixed Maturity Plans (FMPs) An FMP is nothing but a fixed deposit offered by a mutual fund. The current rates for a one-year-plus FMP is around 9-9.5% per annum. After a long-term capital gains tax of 10%, the post-tax yield works out to 8.1-8.5%, much higher than 6.75%.

Arbitrage funds

Arbitrage funds seek to take advantage of the mispricing (arbitrage) opportunities between the cash and the futures market to generate risk-free income. Space constraints prevent a detailed discussion of this concept, but suffice to say that these funds are free of any risk whatsoever. Currently, Kotak, JM, SBI, Lotus and UTI MF offer such schemes. The returns, though not assured, have been in the 8.5-9.5% p.a range in the past.

Readers would have noticed that all these options are in the fixed income space. The US-64 bonds yielded fixed income and one would ideally want to redeploy the money into other, fundamentally sound, fixed-income products.

However, if you have the capacity to take slightly higher risk and have a long-term investment horizon, you could consider investing at least a part of the money into diversified equity funds. Risks can be significantly mitigated by choosing funds that have a sound track record over five years.

Source : DNA