These days lot of companies like PFC, IIFCL, NHPC, etc are
coming up with tax free bonds with interest rates ranging from approximately 8%
- 9%. The interest on these bonds is completely tax-free; there is no TDS (Tax
Deducted at Source). While on the other hand, interest on Fixed Deposits is
taxable as per your Income Tax slab. Previously we had learned how to calculate post tax returns, so that we come to know how much is the net return on hand.
Today we are going to learn how to calculate Pre-Tax Returns, so that it is
easy to compare other fixed return instruments.
What is Pre Tax Return?
Pre Tax Return is the return, is the return that you earn before tax deduction on the income or gains. Like interest on Tax Free Bonds, Long Term Capital Gains on Equity Shares and Equity Mutual Funds is tax free; you do not have to pay any tax on the income or gains on such investment is tax free. By calculating Pre Tax Return we can easily compare the returns on investments that are tax taxable.
Pre Tax Return =
Tax Free Interest Rate / (1 – Tax Rate)
Illustration:
Mr.Sanjay is planning to invest in a PFC Tax Free Bonds for 15
years @ 8.79% per annum. He has an annual income of Rs.6.50 lakhs, and thus in
the second tax bracket of 20.60%. What is his Pre Tax Return?
Solution:
Pre Tax Return = Tax Free Interest Rate / (1 – Tax Rate)
= 8.79% / (1 – 20.60%)
= 8.79% / (1 – 20.60/100)
= 8.79% / (1 – 0.2060)
= 8.79% / 0.794
= 11.07%
