What are capital gain bonds?

Learn all about 54EC bonds’ features, benefits, and tax implications in this comprehensive guide.
What are capital gain bonds?
3 mins
1 August 2023

Capital Gains Bond, also known as Sec 54 EC Bonds provide an opportunity for individuals to save on long-term capital gains taxes incurred from the sale of property or assets. By investing in these bonds, you can defer the payment of capital gains tax and enjoy the potential benefits of a reliable investment option.

To avail of the tax-saving benefits offered by capital gain bonds, investors must invest the capital gains amount in these bonds within a specified period after selling the original asset. The Finance Act of the respective financial year specifies the eligible bonds, along with the time frame for investment.

Why should you invest in capital gains bond? 

Here are some compelling reasons to consider investing in these financial instruments:

  1. Capital gains tax deferral: One of the primary benefits of investing in Capital Gains Bonds is the ability to defer the payment of capital gains tax. If you have recently sold an asset, such as property or stocks, and incurred capital gains, investing the proceeds into these bonds allows you to defer the tax payment. This can be particularly advantageous for managing your cash flow more effectively, as it delays your tax liability to a later date.
  2. Stable returns: These bonds typically offer a fixed interest rate, which ensures a predictable and steady income stream during the tenure of the bond. The interest rates, while not necessarily high, are stable and when combined with the savings from deferred capital gains tax, the overall returns can be competitive with other market investments. This predictability makes them a suitable option for conservative investors or those seeking to balance their investment portfolios.
  3. Low risk: Capital Gains Bonds are considered a low-risk investment option. They are often issued by government entities and are rated 'AAA' by credit rating agencies, which indicates the highest level of creditworthiness. This high rating is reassuring for investors who are risk-averse and seek security for their capital.
  4. Long-term investment option: These bonds are designed for long-term investment. If you are an investor with a long-term horizon and are aiming to reduce your taxable income, Capital Gains Bonds can serve as an excellent choice. The tax benefits, combined with the security and stability of the investment, make them an appealing option for those planning their financial future over an extended period.

Investing in 54EC bonds can thus be a strategic decision, especially for those who have recently realised capital gains and are looking for ways to efficiently reinvest these gains while enjoying tax relief. This type of investment is particularly suitable for individuals seeking to balance the security of their investments with reasonable returns and tax efficiency.

Bonds eligible under section 54EC

The government of India has specified a list of eligible bonds under Section 54EC, which includes bonds issued by Indian Railways Finance Corporation Limited (IRFC), Power Finance Corporation limited (PFC), National Highways Authority of India (NHAI), and Rural Electrification Corporation (REC). These bonds have a fixed maturity period of 5 years and are redeemable after lock-in period is completed. The proceeds received by the investors on maturity or after selling under exceptional circumstances (nailed down) are exempt from being taxed under Section 54EC up to Rs. 50 Lakh. However, if capital gain bonds are sold or converted into cash before reaching maturity, the invested amount that was eligible for tax exemption will be considered as long-term capital gain and taxed accordingly in the year of conversion.

One of the key advantages of capital gain bonds is their ability to provide tax exemption under Section 54EC of the Income Tax Act in India. Investors can claim this exemption by investing up to a specified limit in these bonds within the prescribed time frame. By doing so, they can defer paying the capital gains tax and potentially even avoid it altogether, thereby increasing the overall returns on their investments.

Another attractive feature of capital gain bonds is the security they offer. Being issued by government-backed entities or public sector companies, these bonds are considered relatively safe compared to other investment avenues with market-linked risks. The assurance of a fixed interest rate or coupon rate further adds to the appeal for risk-averse investors seeking stable returns.

However, like any investment option, capital gain bonds have their limitations too. The most notable limitation is the relatively lower interest rates compared to other investment options available in the market. As these bonds are designed to offer tax benefits, the interest rates are usually set at levels that may not match the potential returns of riskier investments like equities. Moreover, the lock-in period restricts liquidity, making it unsuitable for investors who might need access to their funds in the short term.

Example: Let's consider an investor named Mr. Patel who sells a residential property and earns a long-term capital gain of Rs. 60 lakh. To save on capital gains tax, he decides to re-invest Rs. 50 lakh (the maximum permissible limit) in capital gain bonds within the prescribed time frame of six months after selling the property. Assuming the bonds offer an interest rate of 5.75% per annum, Mr. Patel's investment would yield an annual interest income of Rs. 2,87,500 (Rs. 50,00,000 * 5.75%).

As the interest income is taxable as per Mr. Patel's income tax slab, let's assume he falls in the 30% tax bracket. Therefore, he would have to pay Rs. 86,250 (Rs. 2,87,500 *30%) as income tax on the interest earned. However, Mr. Patel can still enjoy the capital gains tax exemption on the original Rs. 50 lakh earned from the property sale.

How to invest in capital gain bonds?

Investing in capital gain bonds is easy and hassle-free, here's how:

Investors can reach out to their bank or financial advisor, who can help them purchase capital gain bonds of NHAI, IRFC, PEC, or REC. They can invest in these bonds online through tie-ups with stockbroking firms and platforms like Bajaj Financial Securities Limited.

Investors are required to submit their KYC documents, bank account details, and other relevant documents for successful investment in capital gain bonds.

Comparison with other tax-saving instruments: Investors should consider comparing capital gain bonds with other tax-saving instruments such as Equity-Linked Savings Schemes (ELSS) or Public Provident Fund (PPF). While capital gain bonds offer the advantage of tax-saving on capital gains, other instruments may provide higher returns and more liquidity. Each option has its own set of benefits and limitations, and investors should align their choice with their financial goals and risk appetite.

Conclusion

In conclusion, capital gain bonds present an attractive proposition for investors looking to save on long-term capital gains tax while supporting the nation's development. They offer a secure investment option with tax benefits, but it's essential for investors to carefully consider their financial goals, risk appetite, and liquidity requirements before committing to these bonds. Consulting with a financial advisor is recommended to make an informed decision and create a well-rounded investment portfolio.

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