Invest in tax-free bonds
Tax-free bonds were issued by government-backed infrastructure entities, and their interest is exempt from income tax under Section 10(15)(iv)(h). For an investor in the highest slab, that exemption is worth more than the headline coupon suggests.
Why the effective yield is higher than the coupon
Because the interest is exempt, the coupon you receive is what you keep. A taxable bond has to pay considerably more to leave you with the same amount after tax, and the gap widens the higher your slab.
The comparison to make is the pre-tax equivalent yield: a tax-free coupon divided by (1 minus your marginal tax rate). At a 30% marginal rate plus surcharge and cess, a tax-free bond paying 5.75% is worth roughly 8.4% pre-tax — which is the number to compare against a taxable bond or a deposit, not the 5.75%.
No new issues, so these trade on the exchange
These bonds were issued between 2012 and 2016 by entities such as NHAI, PFC, REC, IRFC, NABARD and HUDCO. No new tax-free bonds have been issued since, so the only way to buy one is on the secondary market from an existing holder.
That has two consequences. Supply is finite and availability varies, so a particular issue may simply not be purchasable on a given day. And you buy at the prevailing market price rather than face value, which is why the yield to maturity, not the coupon, is what tells you your actual return.
What is exempt and what is not
The exemption applies to the interest. It does not apply to capital gains: if you sell before maturity at a higher price than you paid, that gain is taxable in the normal way.
There is no TDS on the interest, and it does not need to be declared as taxable income, though you should still keep records. As above, this is general information and not tax advice.