Capital Gain Bonds (54EC Bonds) India

Market-linked financial instruments and fixed-income financial instruments are the two categories of financial instruments. Equity shares, equity-oriented mutual funds, and other market-linked financial instruments are examples. Capital Gain Bonds, Government bonds, debentures, fixed deposits, and other fixed-income instruments are examples of fixed-income instruments.

Bonds, which are sometimes known as interest-bearing debenture certificates, are a type of fixed-income financial instrument. In India, government bonds account for the majority of the bond market. These bonds are available to the financial market as well as stock market traders.

Any financial instrument provides an investor with good financial leverage because their existing capital can be leveraged to generate returns rather than sitting idle. Bond investments can also help you avoid paying long-term capital gains tax. 54EC bonds, often known as capital gains bonds, are one type of bond. In this article, we will learn more about Capital Gain Bonds (54EC Bonds).

What are Capital Gain Bonds (54EC Bonds)?

54EC bonds, also known as capital gains bonds, are financial instruments that provide an investor with tax benefits under Section 54EC. After collecting capital gains from the sale of a property, an individual can invest in these bonds and receive the requisite tax exemption. The National Highway Authority of India (NHAI) and the Rural Electrification Corporation have issued bonds (REC.)

How do Capital Gains Bonds help in Tax Exemptions?

The following are the conditions that must be completed in order to qualify for tax exemptions under Section 54EC. –

  1. The capital profits from the sale of a property should be used to fund the investment.
  2. The total amount of investment should not exceed Rs. 50 lakh. If the capital gain in a real estate firm was split by partners, each partner is entitled to a maximum of Rs. 50 lakh.
  3. Investors should invest in NHAI or REC bonds within six months of the property’s selling date or before filing their income tax returns.

If a person fails to invest within the prescribed time frame, he or she might deposit the money in a Public Sector Undertaking (PSU) bank. In that instance, the deposit will be treated as a capital gains bond investment in India, resulting in a tax exemption under the Capital Gains Account Scheme, 1988. If the deposit is not converted into an investment within two years, it will be recognized as a short-term capital gain in the year of expiration.

Only after 5 years can the investor redeem his or her investment. Budget 2019 increased this duration from three to five years. The revenue from interest on these capital bonds has grown in 2020 as a result of this adjustment in the period.

How is Investment in Capital Gains Bonds Better than Other Investments?

This element is influenced by the rate of return as well as the investment’s maturity time.

An example would help to clarify the differences between 54EC bonds and other investment possibilities, as well as if it is more lucrative for an investor to gain more from other investments even if they must pay taxes on them.

Suppose Ms. Y invests Rs. 50,00,000 in NHAI or REC bonds for 5 years at a 5.25 percent capital gains bond interest rate, and Ms. Z invests the same amount in a different kind of investment choice for the same term at a 10% rate of return.

Because the capital gain of Rs. 50,00,000 is now tax-free, the after-tax amount will remain the same. Ms. Z’s payable tax amount is Rs. 13,12,500, lowering her taxable income down to Rs. 36,87,500.

Y’s total income from that bond at maturity would be Rs. 63,12,500, because she would receive 5.25 percent on Rs. 50,00,000. Z’s earnings, on the other hand, would be calculated at 10%, resulting in a total income of Rs. 55,31,250 at maturity. It can be seen that Ms. Z’s amount is less than that of Ms. Y’s. As a result, when it comes to reinvesting capital gains, the rate of return and the maturity term are critical factors to consider.

The example given earlier is illustrated in the table below.

ParticularsCapital gains bonds in IndiaOther forms of investment
Investment amountRs. 50,00,000Rs. 50,00,000
Tax on long-term capital gainNilRs. 13,12,500*
Post-tax amountRs. 50,00,000Rs. 36,87,500
Rate of return5.25%10%
Return received on maturityRs. 13,12,500Rs. 18,43,750
Total amount received on maturityRs. 63,12,500Rs. 55,31,250

*Calculation of LTCG = Rs. (1,12,500 + 30% on 40,00,000)

Different Kinds of Bonds

Individuals can choose from a variety of bonds available on the market. Government bonds, municipal bonds, capital gains bonds, and other government-issued bonds account for the majority of these bonds. The money raised from these bonds is largely invested in infrastructure and real estate by government agencies.

The many types of bonds accessible on the stock market are as follows:–

  1. Government bonds – The central government issues these bonds directly. Sovereign Bonds are another name for them. Because these bonds are issued by the Union, the risk to the investor is minimal. The rates of return on these investments, however, are poor. In January 2018, for example, a 7.75 percent GOI Savings Bond was released, replacing the preceding 8 percent Savings Bond. Government bonds are a good option for someone with a low risk appetite.
  2. Municipal Bonds: Municipal bonds are issued by municipalities and state governments. When compared to high-risk bonds, these bonds also give guaranteed returns, albeit at a lesser interest rate.
  3. Public sector bonds: These bonds are issued by companies or corporations in which the federal government owns at least 50% of the stock. These bonds are likewise low-risk because they are guaranteed by the Indian government.
  4. Corporate bonds: In the stock market, this type of bond is also popular, but it does not cover as much ground as government bonds. Because these bonds are issued by private corporations or companies, they carry a significant risk. They do, however, provide larger yields than government bonds, and anyone with a high risk appetite can take advantage of these investment opportunities.

Indian Financial Market 

In comparison to the equities share market, the Indian financial market is still in its infancy. A small percentage of this is made up of capital gains bonds. It’s because these bonds are only appealing when a person wants to save money by avoiding paying taxes on capital gains from the sale of a home.

Another factor contributing to the reduced demand for these bonds is the interest rate on capital gains bonds (5.25 percent), which is lower than other investment options.

The Finance Minister mentioned in the 2017 Union Budget that additional bonds would be introduced to stimulate the market. However, the minister proposed in the 2018 Budget to extend the lock-in period for 54EC Bonds in order to stimulate demand for this type of financial instrument. The concept was finally enshrined in the Union Budget 2019, which increased the capital gains bond tenure duration to 5 years in 2019.

Capital Gain Bonds are dealt with in two markets – primary and secondary markets.

Primary market

The main market is where bonds and other types of securities are first introduced. These bonds are available for issuance to any entity in need of finance. The duration of the lock-in period as well as the interest rate on these bonds are established ahead of time. This market also saw the introduction of Capital Gain Bonds. If you want to avoid paying taxes on long-term capital gains, you should keep an eye on this market.

Secondary market

This market is where the majority of the exchange and trading takes place. Individuals and corporations alike can profit from the sale of their bonds in this market.

If you want to save money on taxes, capital gains bonds are a terrific way to go. They also participate in the bond market, which requires additional investors, as a result of this. For both the investor and the economy, this is a win-win situation.

Read, also: What Is Capital Gain And What Are Its Different Types?