Chartered Accountants Mumbai

Capital Gain Bonds 54 EC – The BEST way to save Capital Gain Tax

 

Capital Gain Bonds is the best way to save long term capital gain. I will explain it later. The exemption through capital gain bonds is available u/s 54EC. These bonds are issued by NHAI and REC. You can invest through any of the nearest bank branches. Almost all the leading PSU and Private banks issue capital gain bonds. The value of one bond is Rs 10,000. Therefore, you can invest only in multiple of Rs 10,000. In case, your capital gain is Rs 2,37,000 then you should buy 24 bonds worth Rs 2,40,000. The credit rating of capital gain bonds is AAA i.e. highest credit rating. To hedge risk, if i have to buy 24 bonds then i will buy 12 each of NHAI and REC. If you have a demat account then you can buy in a demat form instead of physical bonds. It is always good to hold in electronic form.

The maximum investment allowed during the financial year is 50 lac. In short, you can buy maximum 500 bonds during the financial year. If the capital gain is high then as i shared in my previous post, Capital Gain Deposit Account Scheme that you can invest partial long term capital gain in Capital Gain Bonds. The date of allotment of the bonds is last day of the month during which the amount is deposited in the bond issuer’s collection account. For example, you deposited a cheque on 5th Jan and it is cleared on 9th Jan. The date of allotment, in this case, will be 31st Jan.

The capital gain bonds have a lock-in period of 3 years. Premature withdrawal is not allowed. The bonds are non-transferable and non-negotiable. You cannot avail any loan or advance against capital gain bonds. If you avail loan or advance against bonds then exemption claimed against the bonds will be revoked. The investment and maturity amount of bonds are same i.e. if i invested Rs 2,40,000 then i will receive the same amount at maturity. An important point to note is that upfront you saved 20% LTCG tax. In short, investment of Rs 2,40,000 actually means an investment of Rs 1,92,000 only. The interest of 6% is credited on 1st April every year. The interest is taxable. The unpaid interest will be paid at the time of maturity.

You can invest in capital gain bonds within 6 months from the date of transfer of old property. Here i would like to share interesting ruling of Income Tax Tribunal. The income tax act mention “Month” instead of “Days”. Therefore, Six months start from the end of the month in which the capital gain arises. Assuming i sold the property on 10th Dec, therefore, i can invest in capital gain bonds till 30th June i.e. six months period will start from 1st Jan :). In short, you can invest within 6 British Calendar Months instead of 180 Days.

Another important point is on maximum investment in capital gain bonds. Before the budget 2014, there was a loophole in the system. The taxpayer whose capital gain was more than 50 lac used to sell the property on or after 1st Oct. Assuming, i sold the property on 10th Oct 2012 and the capital gain was 70 lacs. In this case, i had 6 months to invest in capital gain bonds i.e. on or before 10th April 2013. The max limit during FY was 50 lac. Therefore, i will invest 50 lac  in Mar 2013 and balance 20 lac on or before 10th April 2013. In short, i claimed an exemption for full 70 lacs through investment in 2 tranches. Now there are two restrictions (a) Max investment during the financial year is 50 lac and (b) Max investment from the sale of an asset is 50 lac. Therefore, if you are planning to sell more than one property during the financial year and invest in capital gain bonds then please do your calculations.

Capital Gain Bonds – The biggest advantage

The biggest advantage of capital gain bonds is that you can invest long term capital gain from Commercial Property, Non-Agricultural Land, and Under Construction property. I have observed that many clients are more inclined to claim exemption u/s 54F. In short, capital gain from the non-residential property is exempted if a taxpayer buys residential property one year before or two years after the transfer of old property. Alternatively, you can construct new property within three years similar to sec 54. There is a catch that this exemption is available if and only if you own only one residential property on the date of sale of old property excluding the one bought to claim the exemption.

The biggest drawback of section 54F is that instead of capital gain, you need to invest entire sale proceeds in claiming the exemption. For example, if i sold a property for 1 Cr and capital gain is 30 lacs. Depending on the status of the property, the investment amount will vary. If the property is residential then i need to invest only 30 lacs in a new property to save LTCG. On the other, if the property is under construction/non-agricultural land/commercial property then i need to invest entire 1 Cr to claim exemption u/s 54F. In case, i invested, half of 1 Cr i.e. 50 lac then capital gain exemption will also be reduced in same proportion. Therefore, i need to pay capital gain tax on 50% of 30 lacs i.e. 15 lacs and 15 lacs capital gain will be exempted.

Now, assuming i decide to invest capital gain of under construction/non-agricultural land/commercial property in capital gain bonds. In this case, i need not invest entire sale proceeds i.e. 1 Cr in capital gain bonds. I only need to invest capital gain of 30 lacs in claiming 100% exemption. Therefore, i am free to utilize balance 70L. This is the biggest advantage of capital gain bonds. Besides this, you can get double-digit returns even in the highest tax bracket. Another major plus point. Let’s check out.

Double Digit Returns from Capital Gain Bonds

Based on my experience, the major resistance why taxpayer doesn’t prefer capital gain bonds is 6% taxable interest. It is not the right way to calculate returns. The taxpayer forgets that for every Rs 100 invested in bonds, upfront he is saving Rs 20 as LTCG tax. In short, net investment is Rs 80 only. Therefore, another way to look is that you will invest Rs 80 and maturity amount is Rs 100. On top of it, you will get the taxable interest of 6% or post-tax interest of approx Rs 4 in 30% bracket. The post-tax return in 30% income tax bracket is 10.29%. The pre-tax return is 14.71%. Can you generate a double-digit return from property investment? In the current scenario, the answer is NO. Therefore, it is a financially wise decision to invest capital gain in capital gain bonds. The only limitation is a maximum limit of 50 lacs. Hope you liked the post.