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Capital Gain Bonds (54EC Bonds) India
Financial instruments can be divided into two types – market-linked financial instruments and fixed-income financial instruments. Market-linked financial instruments consist of equity shares, equity-oriented Mutual Funds, etc. Fixed-income instruments include government bonds, debentures, fixed deposits, etc.
Bonds are one such fixed-income financial instrument which can also be considered as interest-bearing debenture certificates. Government bonds largely constitute the bond market in India. These bonds are open to the financial market as well individuals dealing in the stock market.
Any financial instrument offers excellent financial leverage to an investor as their existing capital can be used to generate returns for them instead of remaining unused. Investments in bonds can also be done to save on long-term capital gains tax. Such bonds are called 54EC bonds or capital gains bonds.
What are 54EC Bonds?
54EC bonds or capital gains bonds can be described as financial instruments which entail tax exemptions under Section 54EC to an investor. An individual can invest in these bonds after receiving capital gains from selling a property, thus availing the necessary tax exemption. These constitute of bonds from the National Highway Authority of India (NHAI) and Rural Electrification Corporation (REC.)
How Capital Gains Bonds Help in Tax Exemptions?
These are the following conditions which need to be met to avail tax exemptions under Section 54EC –
- The investment amount should originate from capital gains arising out of the sale of a property.
- Investment amount should not exceed Rs. 50 Lakh. In case the capital gain was shared by partners in a real estate business, each partner is entitled to a maximum limit of Rs. 50 Lakh.
- Investment in NHAI or REC bonds should be made within 6 months from the date of sale of the property or before filing their income tax returns.
If the individual fails at investing within the specified time frame, he/she can also deposit the amount in a Public Sector Undertaking (PSU) bank. In that case, the deposit will be viewed as an investment in capital gains bonds in India upon which tax exemption will be available under the Capital Gains Account Scheme, 1988. However, if such deposit does not convert to an investment within 2 years, it will be treated as a short-term capital gain in the year of expiry.
Such investment amount can be redeemed by the investor only after 5 years. This period was extended from 3 years in Budget 2019. This shift in the period has increased the revenue from interest on these capital bonds in 2019.
How is Investment in Capital Gains Bonds Better than Other Investments?
This factor depends on the rate of return as well the maturity period on other investments.
An example would better explain the difference between 54EC bonds and other investment options and whether it is profitable for an investor to gain more from other investments even if they need to incur taxes on those.
Suppose Ms Y invests Rs. 50,00,000 in bonds from NHAI or REC for 5 years with a capital gains bonds interest rate of 5.25% and Ms Z invests the same amount in a different form of investment option for a similar period where the rate of return is 10%.
Now, as the capital gain of Rs. 50,00,000 is exempt from tax, the post-tax amount for it will remain unchanged. In the case of Ms Z, payable tax amount is Rs. 13,12,500 bringing down her taxable income to Rs. 36,87,500.
As Y would receive 5.25% on Rs. 50,00,000, her total income from that bond on maturity would be Rs. 63,12,500. Z’s earning, on the other hand, would be calculated on 10% which would make her total income on maturity Rs. 55,31,250. It can be seen that the amount in case of Ms. Z is less than that of Ms. Y. Therefore, the rate of return and the maturity tenure play a pivotal role in deciding which investment avenue to opt for when reinvesting capital gains.
The following table illustrates the example mentioned above
|Particulars||Capital gains bonds in India||Other forms of investment|
|Investment amount||Rs. 50,00,000||Rs. 50,00,000|
|Tax on long-term capital gain||Nil||Rs. 13,12,500*|
|Post-tax amount||Rs. 50,00,000||Rs. 36,87,500|
|Rate of return||5.25%||10%|
|Return received on maturity||Rs. 13,12,500||Rs. 18,43,750|
|Total amount received on maturity||Rs. 63,12,500||Rs. 55,31,250|
*Calculation of LTCG = Rs. (1,12,500 + 30% on 40,00,000)
Different Kinds of Bonds
There are different kinds of bonds available in the market for an individual to choose from. These bonds are dominantly from the government bodies such as Government bonds, Municipal bonds, capital gains bonds, etc. Funds collected from these bonds are mostly used by Government organisations to invest in infrastructure and real estate.
The different kinds of bonds available in the stock market are –
- Government bonds – These bonds are directly issued by the Central Government. They are also called Sovereign Bonds. As these bonds are issued by the Union, they incur low risk for the investor. However, the rates of return on these investments are low. For example, recently a 7.75% GOI Savings Bond was introduced in January 2018 which replaced the previous 8% Savings Bond. An individual with a low-risk appetite can opt for government bonds.
- Municipal Bonds: Municipal bonds are issued by State governments and municipal corporations. These bonds also provide assured returns, albeit against a comparatively lower interest rate when compared to high-risk bonds.
- Public sector bonds: These bonds are issued by companies or corporations whose 50% shares or more are owned by the Central government. These bonds also have a low-risk factor as these are guaranteed by the Government of India.
- Corporate bonds: This kind of bonds is also popular in the stock market; however, it does not cover as much ground as government bonds. That is because these bonds entail high risk because these are issued by private corporations or companies. However, they offer higher returns compared to government bonds and an individual with a high-risk appetite can avail these investment avenues.
Indian Financial Market
The Indian Financial market can be said to be in its nascent stage compared to the equity share market. Of this, a small portion is comprised of capital gains bonds. It is because these bonds are only desirable when an individual prefers to save through tax exemption when they generate capital gains from selling a property.
Another factor which adds to the lower demand of these bonds is the capital gains bonds interest rate (5.25%) which is comparatively lower than other investment avenues.
In Union Budget 2017, the Finance Minister talked about introducing newer bonds to boost the market. However, in the 2018 Budget, the minister proposed an increase in the lock-in period for 54EC Bonds to raise the demand for this type of financial instrument. The proposal was finally institutionalised in the Union Budget 2019, making the tenure period to 5 years for capital gains bonds in 2019.
Bonds are dealt in two markets – primary and secondary market.
Bonds or any form of security is introduced through the primary market. Any entity which requires funds can throw access these bonds for issuance. The lock-in tenure as well the interest rate on these bonds is determined beforehand. Capital gains bonds were also introduced into this market. Therefore if you are looking for tax exemption on LTCGs, you need to monitor this market closely.
The bulk of all exchange and trading happens in this market. Individuals, as well as corporations, can sell their bonds in this market and generate capital gains.
Capital gains bonds are a great option for anyone looking to save on taxes paid. Through this, they also become a participant in the bond market, which requires more investors. It can be considered a benefiting situation for both the investor and the economy.