In the space of Investment, many of you know How to invest, and when to invest but very few of you know where to invest? Right. Even if you had made some investment, most probably you must have paid Income tax too. Well, there is a way you can avoid paying tax by investing an amount equivalent to the long-term capital gains in bonds specified under Section 54 EC of the Income-Tax Act.
1. Before moving to direct Instruments First, know what is Bond?
A bond is a debt instrument in which an investor loans money to an entity (typically corporate or government) which borrows the funds for a defined period of time at a variable or fixed interest rate.
Bonds are used by companies, municipalities, states and sovereign governments to raise money to finance a variety of projects and activities. Owners of bonds are debt holders, or creditors, of the issuer.
2. About Capital Gains Bonds – 54EC
Long-term capital gain is the gain that is derived out of a sale of an asset (Land, Building, House) that has been held for more than two years. You can invest the gain in certain specified bonds to claim tax exemption within 6 months of the date of sale of the asset.
54EC bonds, or capital gains bonds, are one of the best ways to save long-term capital gain tax arising out of the sale of a capital asset. The maximum limit for investing in 54EC bonds is Rs. 50,00,000.
The eligible bonds under Section 54EC are :
- REC (Rural Electrification Corporation Ltd),
- PFC (Power Finance Corporation Ltd),
- IRFC (Indian Railways Finance Corporation Limited).
Earlier NHAI was also offering 54EC Bonds, but w.e.f 1 April 2022, NHAI discontinued its offering.
3. Features of 54EC Bonds
A person can invest as little as Rs 20,000 in capital gains bonds; the maximum investment limit in a financial year is Rs 50 lakh. However, in the case of jointly-held assets like real estate, each owner has a separate limit of up to Rs 50 lakh for investing in these bonds.
These bonds are generally backed by the government and assured with the highest rating AAA from rating agencies, therefore considered as safest investments.
But the problem is the long five-year lock-in period and a meagre interest of 5% per annum, which too taxable in the hands of the investor.
4. Let’s Understand as an Illustration
As we have mentioned, Let’s say you had a property/Capital asset which you had purchased for Rs. 2Cr 2 years back and now sold for Rs. 2.5 Cr, So for this transaction, you made Rs. 50 Lacs which would be considered Capital Gains.
So, to avoid paying LTCG Tax which is 20% right now, you can park your gains in REC Bonds and PAF Bonds. Hence your Taxable capital gain becomes 0 and LTCG tax would be exempt.
5. Who should invest and who should not?
Investors who are fine with the five-year lock-in may invest in these bonds in order to save tax.
If the tax payable on capital gains is minor, or the investor needs the funds immediately, he/she should pay the 20 per cent tax, and not invest in these bonds. On the other hand, if the tax liability is significant, they may be considered. Investors can also pay tax and invest the balance in instruments, such as direct equities and equity mutual funds, which have the potential to offer higher returns. Those having a long horizon may exercise this option.
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Disclaimer: The report only represents the personal opinions and views of the author. No part of the report should be considered a recommendation for buying/selling any stock. Thus, the report & references mentioned are only for the information of the readers about the industry stated.
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