In the union budget of 2018, finance minister already proposed the plan of increasing the lock-in period of the investments within the capital gain tax exemption bonds up to the period of 5 years.This is under the section 54EC of Income Tax Act, 1961. The budgeting of 2017, already indicated about introducing more financial instruments which could save the tax over capital gains. Although, this year they just increased the term period of the bonds! Well the lock period or tenure, actually plays a key role in deciding whether a fund is sensible enough to be invested within or not? Similarly, a longer lock in period within bonds also brings some significant changes. Let's figure out whether investment of capital gains in 54EC bonds is successful or not?
Tax exemption benefits through 54EC bonds
Capital gains or long term capital gains are the ones generated after transfer of capital assets such as jewelry, bullion or properties. Thus, if any such income has incurred in your accounts, then you are capable of availing the benefits posed by section 54EC. These are the gains which a person makes when he sells any of the capital asset and which must have been held for above a period of 3 years. so, one of the most significant ways of saving taxes on the long term capital gains is through investing them in the bonds issued by the REC or NHAI. The maximum limit for any similar investment within any financial year turns out to be Rs. 50 lakh. The major function of these bonds is tax saving, although they are even known for a modest interest rate of 5.75% per annum (March, 2018).
Although the interest paid on capital gain bonds is low, as compared to that of fixed deposits, the capital tax being saved turns out as the highest reward in here. Generally the investment has to be done right within 6 months from the date of transfer so as to be eligible for claiming of the benefit of deduction within the 54EC. Also, the face value of such bonds stays to be Rs 10,000, and full amount is supposed to be paid up front with the application.
If due to any reason you plan to pay the LTCG tax, then it would be near to the rate of 20.6% however, you would get the advantage of indexation. Still, even after considering indexation, let's assume that you make a capital gain of 50 lakhs. Now, investing this in 54EC bonds will give you a return of 5.75% and will also lock up the sum for 5 years. After the period ends, you will attain around 64.58 lakhs. Thus a combination of your extended tenure and the low interest rate would drive the taxpayers toward better returns on their capital gains through bonds.
|||54EC Bonds||Pay Tax & Invest in other options|
|Capital Gains||Rs. 50,00,000||Rs. 50,00,000 |
|LTCG Tax||Nil||~Rs. 10,40,000|
|Post Tax Amount||Rs. 50,00,000||Rs. 39,60,000|
|Investment Tenure||5 Years||5 Years|
|Rate of Return (Per Annum)||5.75%||11%|
|Maturity Value||Rs. 66,12,594||Rs. 66,72,830|
Now, if you look forward to other alternatives like fixed return ones, then you could opt for Government of India's 7.75% Savings Bonds, (Taxable) 2018. However, investments in such bonds would also not help as after factoring within the tax implications, the returns generated here would not be able to match up the pace of 54EC bonds.
Opting for mutual funds is also a safe deal. Because in long term, the returns generated from them are considered as more tax efficient. However, you must remember that their returns are not the guaranteed ones. To bring in better and positive returns like 54EC bonds, these funds have to show up with at least 10.27%, pre taxation. Returns are not everything. If you invest in 54EC bonds, then you need to take into account the complete lack of liquidity for the entire period of 5 years.
Another alternative to save taxes on the capital gains is through reinvestment of the capital gain in any residential property. Unlike those tax saving bonds, the limit of investing in any property is not restricted. However, you can just buy a single property with the use of your gains.
Conclusion: If the rate of return is higher than 10.27% in the other investment options, then investing in them makes sense, else better to go ahead with 54EC. After the consideration of all such issues and factors, people who are willing to avoid market risk, when their capital gains from the selling of assets is not meant to satisfy their near term goals,then you must prefer to choose the 54EC bonds.