What 'tax-free PSU bond' actually means
A 'tax-free bond' under Section 10(15)(iv)(h) is a bond issued by a notified Public Sector Undertaking (PSU) whose interest payable to the holder is fully exempt from income tax in India. The exemption sits on the interest income line — capital gains on sale of the bond are still taxable.
Section 10(15)(iv)(h) requires CBDT to specifically notify the issuer and the issue. The issue must be in the form of bonds with at least three years' maturity, listed on a recognised stock exchange, and issued by an entity wholly owned by Government or an institution / authority approved by Central Government.
Between 2012-2013 and 2015-2016 the Government authorised PSU issuers to raise approximately ₹50,000 crore in tax-free bonds. The eligible issuers were:
• Power Finance Corporation (PFC) • Rural Electrification Corporation (REC) • Indian Railway Finance Corporation (IRFC) • National Highways Authority of India (NHAI) • Housing and Urban Development Corporation (HUDCO) • Indian Renewable Energy Development Agency (IREDA) • National Hydroelectric Power Corporation (NHPC) • National Thermal Power Corporation (NTPC) • National Bank for Agriculture and Rural Development (NABARD) • Airports Authority of India (AAI), in some tranches
No fresh tax-free PSU bond issuances since FY 2015-16. The Government discontinued the programme — partly because alternative routes (Sovereign Gold Bonds, capital gains tax exemption bonds under Section 54EC) were preferred, partly because of fiscal reasons. All available stock today is secondary-market paper from those 2012-2016 issuances.
How the exemption works for the holder
The exemption is at the interest payment: the issuer (REC / NHAI / etc.) does not deduct TDS on coupon payments. Section 197A operationalises this — the issuer's compliance team flags the bond as Section 10(15)(iv)(h) instrument, and no TDS is deducted on the coupon credit, regardless of whether the holder is resident or non-resident.
For an NRI holder, this means:
• The coupon credits to your NRE / NRO bank account in full, without any TDS. • The interest is exempt from Indian income tax — no Section 195 TDS, no slab-rate addition to your Indian taxable income. • You report the coupon as exempt income in your ITR-2 (under 'Income claimed as exempt' / Schedule EI), but it doesn't add to your Indian tax liability.
The exemption is permanent in nature — it doesn't depend on your residence status. NRI, RNOR, or ROR all get the same exemption on the bond interest. (This is different from NRE / FCNR exemption, which ends when you become FEMA-resident.)
Capital gains on sale ARE taxable. If you buy in the secondary market at one price and sell at another, the gain is a capital gain under Section 112 (these are listed bonds, treated as listed securities other than equity). Holding period > 12 months: 12.5% LTCG flat (post-FA 2024). Held ≤ 12 months: STCG at slab rate. So 'tax-free' refers to the interest only — the bond itself is a regular capital asset.
Current secondary market — what's actually available
All tax-free PSU bonds are listed on NSE and BSE. They trade on the wholesale debt market segment with limited retail liquidity, but most major PSU bond series (PFC, REC, IRFC) have decent volume on retail platforms.
Key parameters of typical tranches:
• Coupon rate (original): 7.0% to 8.5% per annum, paid annually or semi-annually depending on tranche • Maturity: 10, 15, or 20 years from original issue (so most have 1-5 years of residual life remaining as of 2026) • Face value: ₹1,000 per bond • Listing: NSE / BSE wholesale debt market, settled via demat
Yield-to-maturity (YTM) on secondary market: Because the original coupons (7-8.5%) are higher than current G-Sec yields, the bonds trade at premium to face value. YTM for residual-tenor 1-5 year tax-free bonds in 2026 is approximately 5.0-6.5%, depending on issuer credit and remaining tenor. The 5-6.5% YTM is fully tax-free in India, equivalent to a pre-tax yield of 7.5-9.5% for a 30%-bracket taxpayer.
Liquidity considerations: Daily trading volumes vary by series. PFC and REC bonds typically have the most liquidity; HUDCO and NABARD tranches have less. For a retail NRI buyer, broker desks at ICICI Securities, Zerodha, Kotak Securities, and IndiaBonds.com can source paper at modest spreads. Expect 0.10-0.30% bid-ask spread on liquid issuers.
Credit risk: PSU credit. All issuers are wholly or majority Government-owned; sovereign-implicit-backing makes default risk negligible for the principal. Credit ratings on these tranches are typically AAA(SO) or AA+(SO) by CRISIL / CARE / ICRA — among the safest INR-denominated paper available.
How NRIs buy and hold tax-free PSU bonds
Step 1 — open a demat account. NRI demat options:
• NRE-funded demat with PIS (Portfolio Investment Scheme) account, or • NRO-funded demat without PIS, or • FCNR-funded → NRE → demat for foreign-currency-sourced NRIs
Most major brokers (ICICI Direct, Zerodha, Kotak Securities, HDFC Securities, IIFL) offer NRI demat with KYC turnaround of 1-3 weeks.
Step 2 — fund the demat. For tax-free bond purchases:
• NRE-funded is the cleanest path. Coupon credits land in NRE (along with the principal at maturity); the NRE account is freely repatriable. • NRO-funded works but coupon credits land in NRO; subject to USD 1M / FY repatriation.
Step 3 — place the secondary-market purchase order. Search for the bond by ISIN (each PSU tranche has a unique ISIN). Common identifiers: 'IRFC TAX FREE 2025', 'PFC TAX FREE 2027', etc. Confirm the ISIN, coupon, maturity, and current YTM with your broker before placing the order.
Step 4 — coupon collection. Coupons credit automatically to your linked bank account via ECS / NEFT on the coupon date. The bank account is your demat-linked account (NRE for NRE-routed purchases, NRO for NRO-routed).
Step 5 — at maturity. The issuer redeems at face value. The principal credits to your linked bank account. Any difference between your purchase price and face value is the capital gain/loss for that bond.
ITR reporting: Coupons reported as exempt income in Schedule EI ('Exempt Income') of ITR-2. Capital gain on sale (if any) reported in Schedule CG.
Tax in your country of residence — varies
Section 10(15)(iv)(h) is an Indian exemption. Your country of residence usually doesn't recognise the Indian tax-free status; you may need to declare the coupon as taxable income.
United States: Indian tax-free bond coupons are fully taxable on Form 1040 Schedule B as ordinary interest income. There is no FTC because India levied zero — same as NRE / FCNR. State tax adds. This is the same trap as NRE — Indian-side exemption doesn't help if your residence-state taxes worldwide income.
United Kingdom (post-FIG abolition): Fully taxable on Self Assessment SA106 at up to 45%. No FTC.
Canada / Australia / EU: Generally fully taxable; FTC unavailable because India levied zero.
Gulf states (UAE, Bahrain, Saudi, Kuwait, Oman, Qatar): No personal income tax. Genuinely double-zero — Indian exemption + zero residence-state tax = real after-tax yield matches the 5-6.5% YTM.
Singapore / Hong Kong: Foreign-source-territorial regimes generally exclude Indian bond coupons unless remitted (Singapore) or sourced locally (HK). Effectively double-zero in most cases.
The dispiriting truth for US / UK NRIs: the Indian tax-free positioning saves you Indian tax (which would have been 30% under Section 195 had it been a regular bond), but your home-country tax treats the income normally. Net effective tax: roughly your home-country slab rate (37% US federal + state, ~40% UK).
Where this STILL wins for high-bracket NRIs: even at 40% home-country tax, the after-tax yield on a 6% YTM tax-free bond is ~3.6%. Compare against a US Treasury 5-year (~4.0% pre-tax, ~2.4% after federal+state) or a high-yield USD savings (~4.0% pre-tax, ~2.4% after-tax) — the Indian tax-free bond delivers ~120 bps of after-tax outperformance for an NRI in a high US bracket.
Where this fits — capital preservation, sleeper-pick tier
Tax-free PSU bonds are a capital-preservation product with a peculiar profile:
• Highest Indian-side tax efficiency of any fixed-income product (zero tax, regardless of residence status — better than NRE / FCNR which end on FEMA-resident transition) • Long-dated (1-5 years residual maturity from 2026 perspective) — locks in current yields • Listed and tradable — can sell before maturity if needed • PSU credit — sovereign-implicit; default risk negligible • No new issuances — finite supply; some series will be retired by their original 10/15/20 year maturity dates over the next decade
Best for:
• High-bracket US / UK / Canadian NRIs in 30%+ home-country slab. The Indian tax-free positioning + after-residence-state tax usually outperforms equivalent USD-side bond yield. • Returning NRIs planning their RNOR-to-ROR transition. Section 10(15)(iv)(h) exemption survives the residential-status change — an NRE FD's tax exemption does not. So tax-free PSU bonds bridge the RNOR-to-ROR transition cleanly. • Long-duration NRI fixed-income allocators who want yield certainty over a 3-5 year horizon and don't need the principal in the short term.
Worst for:
• Gulf NRIs. NRE FDs at 7%+ INR (also tax-free in India and zero residence-state tax) typically outyield tax-free bonds at 5-6.5%; INR depreciation can eat the difference but for Gulf NRIs the simpler NRE path usually wins. • Anyone needing principal liquidity within 12 months. Bond prices move with interest-rate cycles; sale at the wrong time crystallises a loss. • NRIs unfamiliar with Indian secondary bond markets. Liquidity is decent but not retail-equity-level; spreads are real. First-time NRI bond buyers should size positions accordingly and test the broker's execution.
Compared to other capital-preservation NRI products:
| Product | Tax in India | Tax in US (typical) | After-tax yield | Term flexibility | | --- | --- | --- | --- | --- | | Tax-free PSU bonds | Zero (Section 10(15)(iv)(h)) | ~37% slab | ~3.5-4.1% (US) | 1-5 year residual | | NRE FD | Zero (Section 10(4)(ii)) | ~37% slab | ~4.5-5.0% (US) | Flexible up to 5y | | FCNR (B) USD | Zero (Section 10(15)(iv)(fa)) | ~37% slab | ~3.0-3.5% (US) | 1-5 years | | GIFT IFSC FCY FD | Zero (Section 10(15)(viii)) | ~37% slab | ~3.4-3.8% (US) | 6m-5y | | Indian Equity MF | 12.5% LTCG | + PFIC complexity | 6-9% expected | Long-term only |
For a high-bracket US/UK NRI, the rough order of attractiveness within capital-preservation: NRE FD ≈ tax-free PSU bond > IBU FCY FD > FCNR (B). The exact ranking flips with INR forecasts, residence-state slab, and operational preference.