TDS Adds Another Wrinkle To Floating Rate Savings Bonds

The Floating Rate Savings Bonds, also known as Government of India Floating Rate bonds, have been an option to earn regular returns for fixed income investors for a long period of time. Some time ago, the interest rate on these bonds was made floating in nature, which means that they could very well change several times over the life of the bonds.

Now, the Union Budget 2024 has proposed a tax deduction at source on the interest payments. This adds another wrinkle for those who are considering the bonds as an investment.

Here is a detailed evaluation of the option that is available for the investors.

The floating rate savings bonds are a seven-year investment option where the investor is able to get a payout of interest twice a year in January and July. The bond has a floating interest rate, which means that the interest rate can change as per the situation that is prevailing in the market.

The interest rate of the bond is linked to the interest rate paid on the National Savings Certificate. The investor will get 0.35% more than the applicable rate on the NSC. This makes it an attractive option in terms of the interest rate as the prevailing situation means that the current interest rate (August 2024) would be 8.05%.

The interest that is earned on these bonds is taxable in the hands of the investor. This is an important part of the equation because the tax rate applicable here depends on the level of income of the individual.

The income would be classified as income from other sources. The figure would be a part of the total taxable income of the individual, so the applicable tax rate would be the marginal tax rate applicable to the taxpayer.

For example, if someone has adopted the new tax regime and they fall in the 10% tax bracket, then they would end up paying tax at this rate. On the other hand, if someone falls in the 30% tax bracket, then their rate would be this higher rate.

There is now an added element to the overall tax process when it comes to the floating rate savings bonds. The Union Budget 2024 has added the provision for a tax deducted at source from the income of these bonds. This will be applicable from Oct 1, 2024. There is a threshold limit of Rs 10,000, after which the tax would be cut. This means that there is no TDS if the income earned during the year is less than Rs 10,000.

Once the figure crosses this mark, then the tax would be deducted at a rate of 10%. This is just a procedural aspect because it does not change the final nature of the taxation of the income. This remains the same as before. What will happen is that the investor will receive the interest calculated after deducting the TDS figure so the cash that they get in their bank account will be impacted.

There are two impacts that need to be considered where the first is the hit on the cash flow, especially for those who use these bonds as a means of generating regular income. There will be an impact at the time of the receipt of the amount, especially if the figure is high because the TDS will reduce the amount coming in. This would require a reworking of the entire cash flow position.

However, there would be a relief later on as part of the tax would be paid through this route and this will require a lesser amount of tax payment on their own for the individual. In terms of the overall instrument investment, there is a lower liquidity that is present for this bond. The holding period is also slightly longer and hence, only those investors who feel that they have the funds that they can deploy for this time period without needing to access it can use it for their investment needs 

Arnav Pandya in the founder of Moneyeduschool.