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Should you need to invest in capital gain bonds?

How can you save your Capital Gain tax? Should you need to invest in Capital Gain bonds?

Do you have Capital Gains from the sale of properties?

If so, do you need to pay a tax of 20% or save Capital Gains tax instead?

Or do you think paying tax and investing further will earn you better returns?

What do you think which will be the better option for your financial life?

In this article, we are going to see,

1. Why should you buy Capital Gain bonds?

A Capital Gain refers to profit from the sale of capital assets such as properties, stocks or bonds and tax that levied on such gains is known as Capital Gains tax.

However, Long term Capital Gain tax from land and building can be saved by investing the sale proceeds in Capital Gains bonds under Section 54EC.

Interesting isn’t it? Do you know how much tax you will save if you invest in Capital Gain bonds?
You will be saving 20% of tax on long term Capital Gains.

Huge isn’t it?

Capital Gains that are held for a shorter period are known as Short term Capital Gains for which this exemption is not applicable.

While Capital Gains which are held for a longer period (more than 2 years) known as long term Capital Gains. This amount can be invested in Capital Gain bonds to save long term Capital Gain tax.

2. Who issues Capital Gain bonds?

Capital Gain bonds which help in saving tax are only issued by the government authorities through,

    NHAI – National Highway Authority of India and
    REC    – Rural Electrification Corporation.

And, it can be held either in Demat form or Physical form.

Since Capital Gain bonds are issued by the government, it is much safer than any other investments.

Yes, Government usually assures people and they repay the amount.

3. Who is eligible to invest in Capital Gain bonds?

According to Section 54EC of Income Tax any person individuals, HUF’s, partnership firms, companies etc are eligible to invest in Capital Gain bonds for a Maximum of Rs. 50 lakhs as an investment.

4. The interest rate on Capital Gain bonds.

Capital Gain bonds provide a 5.75% interest rate which is payable annually by NHAI as well as REC. Before April 1, 2018, the interest rate was 5.25%.

Both the REC bonds and NHAI Bonds provide the same 5.75% rate of interest at present.

There is no cumulative interest option available.

5. Is there any lock-in- period?

The lock-in period of Capital Gain bonds was implemented under Section 54EC for the purpose to save tax. Earlier it was for the period of 3 years and now it became to 5 years effective from 1st April 2018.

Lock in period or tenure of investments plays a vital role in deciding whether to invest in it or not.

For example,

A and B are planning to invest their Capital Gains in Capital Gain bonds. A is a person who has sufficient funds for his needs other than Capital Gains but B is a person who lacks liquidity and has only Capital Gains.

Tax Return side box

Whom do you think will be suitable for this Capital Gain bonds? Yes, obviously ‘A’. Because they both have a lock-in period of 5 years. In case if there is an emergency, then person A can easily meet the emergency expenses with his adequate fund.

Person B doesn’t have an adequate liquid amount. If he invests in Capital Gain bonds for 5 years, the money will be locked. He will not be having the liquidity to meet his emergency.

 

6. Can I transfer the bond?

No, Capital Gain bonds are purely non- transferable. Transferability means… if an investor needs any liquidity he can transfer his bonds to another person to encash it. This is not possible with this Capital Gain bonds.

7. Is it taxable?

The amount invested is exempted from Capital Gains tax but the interest that is earned on these bonds is liable to income tax.

If the amount invested in bonds is less than the Capital Gains realized, only proportionate Capital Gains would be exempt from tax.

8. How many bonds I can buy?

Minimum 2 bonds of Rs. 20000 and Maximum of 500 bonds can be purchased at Rs.10000 per bond i.e, Maximum investment limit of up to Rs.50 lakhs in a financial year per individual. The exemption will be the amount of Capital Gain or the amount of investment made, whichever is lesser.

9. Are NHAI Bonds or REC bonds the same?

 

NHAI bonds REC bonds
Type National Highways Authority of India under Sec 54EC Rural Electrification Corporation Ltd under Sec 54EC
Tenure 5years 5years
Interest Rate 5.75% p.a. from April 2018 5.75% p.a. from April 2018
Credit rating CRISIL “AAA” Stable rating CRISIL “AAA” Stable rating
Minimum Investment Two bonds at Rs.10,000 per bond i.e., Rs.20,000 minimum investment Two bonds at Rs.10,000 per bond i.e., Rs.20,000 minimum investment
Maximum Investment 500 bonds of Rs.10,000/- each i.e.,Rs.50,00,000 in a financial year 500 bonds of Rs.10,000/- each i.e.,Rs.50,00,000 in a financial year
Tax Interest is taxable. Interest is taxable.
Mode of subscription 100% on application 100% on application
Transferability Non- transferable and cannot be offered as a security for any loan or advance. Non- transferable and cannot be offered as a security for any loan or advance.
Maturity An investor needs to apply for surrender of bond certificates on maturity. Then only, redemption is processed and paid. Bonds will be automatically redeemed by REC on maturity without the surrender of Bond Certificates and the proceeds would be paid by cheque or ECS.

REC bonds score a bit higher than NHAI bonds. Because on maturity i.e., after 5 years, NHAI bondholders have to apply for surrender of bonds only then the maturity amount is redeemed and paid by cheque or ECS. In the case of REC bonds, it will be automatically redeemed and paid by cheque or ECS.

10. Does these NHAI and REC bonds save tax?

You may think that these bonds provide only 5.75% taxable return which is lesser compared to other investments.

But the positive side of these bonds are,

    – As compared to other investments, NHAI and REC bonds not only provide you returns with taxable interest. But also saves 20% LTCG tax which is one of the advantages to invest in these bonds.

    – The credit rating for these Capital Gain bonds is CRISIL AAA rating i.e., highest credit rating. This helps you to know about the bonds creditworthiness and the ability to repay the principal and interest on time.

    – Long term Capital Gains arising from the sale of Commercial property, Non- agricultural land, and under construction property.

11. Fixed Deposits Vs Capital Gain Bonds

The interest earned on these Capital Gain bonds of 5.75% is lower as compared to the interest on a fixed deposit which is around 7%.

So, at the surface level, it looks like 7% FD is better. Let us dive deep and understand reality.

If you invest in Fixed Deposits, you need to pay the long term Capital Gain tax from the sale of property and you can invest only the balance in Fixed Deposit.

Let me illustrate on this with Capital Gains of Rs.50,00,000 for 5 years on different income slabs.

 

Investing in Capital Bonds Vs Fixed Deposits (5% Tax Bracket)

 

Investing Amount (Rs.) Investment after LTCG tax(Rs.) Interest Rate (%) Interest Amount (Rs.) Tax Amount (5%) Earnings Earnings after 5 years Closing Balance
Capital Bonds – No LTCGT 5000000 5000000 5.75 287500 14375 273125 1365625 6365625
Fixed Deposit – 20% on LTCGT 5000000 4000000 7 280000 14000 266000 1330000 5330000

 

Investing in Capital Bonds Vs Fixed Deposit (20% Tax Bracket)

 

Investing Amount (Rs.) Investment after LTCG taxv(Rs.) Interest Rate (%) Interest Amount (Rs.) Tax Amount (20%) Earnings Earnings after 5 years Closing Balance
Capital Bonds – No LTCGT 5000000 5000000 5.75 287500 57500 230000 1150000 6150000
Fixed Deposit – 20% on LTCGT 5000000 4000000 7 280000 56000 224000 1120000 5120000

 

Investing in Capital Bonds Vs Fixed Deposit (30% Tax Bracket)

 

Investing Amount (Rs.) Investment after LTCG tax(Rs.) Interest Rate (%) Interest Amount (Rs.) Tax Amount (30%) Earnings Earnings after 5 years Closing Balance
Capital Bonds – No LTCGT 5000000 5000000 5.75 287500 86250 201250 1006250 6006250
Fixed Deposit – 20% on LTCGT 5000000 4000000 7 280000 84000 196000 980000 4980000

From the above table, NHAI and REC bonds yield better than Fixed Deposits. More than returns, the prime benefit of investing in these Capital Gain bonds is not just the interest earned but also the Capital Gains tax which is being saved.

Comparing Capital Gain bonds with Mutual funds.

Mr. Ganesh invested in Real estate and earned Rs.1,00,00,000 Capital Gains. Further, he decided to reinvest his Capital Gains equally on Equity funds and Capital Gains bonds. Let us check what will be his returns finally?

 
Investing in Capital Gain bonds

Tax slab Investing Amount (Rs.) Investment after LTCG tax(Rs.) Interest Rate (%) Interest Amount(Rs.) Tax Amount(30%) Earnings Earnings after 5 years Closing Balance
5% 5000000 5000000 5.75 287500 14375 273125 1365625 6365625
20% 5000000 5000000 5.75 287500 57500 230000 1150000 6150000
30% 5000000 5000000 5.75 287500 86250 201250 1006250 6006250

 
Investing in Equity Mutual Funds

Capital Gain : Rs. 50 lacs

LTCG tax paid: 20% = 10 lacs

Net Amount invested after LTCG Tax = 40 lacs

Opening Balance Investing Amount after LTCGT Expected Rate of Returns* Appreciation amount (Rs.) Tax Amount (10%) Closing Balance (Rs.)
0 4000000 12% 480000 0 4480000
4480000 12% 537600 0 5017600
5017600 12% 602112 0 5619712
5619712 12% 674365.4 0 6294077
6294077 12% 755289.3 0 7049367
7049367 3049367 304936.7 6744430

*  12% is the rate of return assumed for equity mutual funds.

Equity Funds are taxed on a flat 10% for its long term Capital Gains. So regardless of your income tax slab, you will be taxed at 10% for long term Capital Gains.

Comparatively, Equity Mutual Fund earns a much better return than Capital Gain bonds. But the only problem with the equity investment is that they are high risk-oriented investments. Capital Gain bonds earn a much lesser return as compared to equity. The main USP of Capital Gain bonds is they save long term Capital Gain tax.

If you are comfortable with the risk associated with equity funds, then you can avoid investing in Capital Gain bonds and just pay the LTCG tax and reinvest the balance in equity funds. The returns from equity funds will be more than the returns from the Capital Gain bonds and also the tax amount saved by way of investing in Capital Gain bonds.

12. Final Verdict

If you have enough liquidity, then you can lock up your money and invest in Capital Gain bonds. If you don’t have liquidity, then instead of locking up your money, you may avoid investing in Capital Gain bonds and pay the long term Capital Gain tax. You can invest the balance money in liquid investments like Fixed Deposits or debt funds.

If you have an appetite for risk, then you have one more alternative. That is you can pay the long term Capital Gain tax and invest the balance money in equity funds which can deliver much higher returns in the long run.

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