Capital Gain Bonds

What are Capital Gain Bonds?

Capital Gain Bonds in India allow individuals to claim tax exemption on the Long Term Capital Gains (LTCG) arising from the sale of immovable property or land. Taxpayers can invest the entire LTCG component or a part of it (capped at Rs 50 lakh per financial year) in these bonds to claim the tax exemption.

The profit from the sale of land or property after two years of its acquisition is considered as long-term capital gains. For properties acquired before July 23, 2024, LTCG on property sale is taxed @ 12.5% without indexation or 20% with indexation. For properties acquired on or after July 23, 2024, LTCG arising from the property transfer would be uniformly taxed @12.5% without any indexation benefits. As the exemption on LTCG tax on investing in Capital Gain Bonds has been specified in Section 54EC of the Income Tax Act, such bonds in India are also popularly known as Section 54EC Bonds.

How to Invest in Capital Gain Bonds in India?

Capital Gain Bonds in India are not listed on the stock exchange. Therefore, investors have to purchase capital gain bonds directly from the issuer in a demat form or a physical form within 6 months of selling their long term capital asset. Investors can also visit authorized bank branches to fill in the original application form of Capital Gain Bond, submit the necessary documents and a cheque/demand draft.

Features of Capital Gain Bonds

1. Investment Deadline To Qualify for Tax Exemption

Taxpayers would have to invest their LTCG component in the capital gain bonds within 6 months of the date of property transfer.

2. Capital Gains Bonds Coupon (Interest) Rate

Capital Gains Bonds issued during the current financial year are offering coupon (interest) rates of 5.25% p.a.

3. Minimum Investment Amount

At least 2 bonds of Rs 10,000 each have to be invested to claim tax exemption under Section 54EC.

4. Maximum Investment Amount:

Taxpayers can invest up to a maximum Rs 50 lakh, i.e., 500 bonds, in each financial year.

5. Tenure

Capital Gain Bonds have a tenure of 5 years. However, the investment in the bonds would be locked in throughout its tenure, i.e., 54EC bonds can neither be transferred nor redeemed nor pledged for availing any loan/advance during their tenure. 54EC Bonds are automatically redeemed after the completion of 5 years.

6. Capital Gain Bonds Interest (coupon) Payment Frequency

Capital Gain Bonds provide annual interest pay-outs to their investors. The date of interest payment varies from issuer to issuer. For instance, the interest pay-out for REC Capital Gains Tax Exemption Bonds would be made on June 30th every year and for PFC Capital Gain Tax Exemption Bonds the date of coupon payment is 31st July of each year.

Taxation of interest income from Sec 54EC Bonds

The interest income earned from capital gain bonds is taxable as per the taxpayer’s income tax slab. However, no Tax Deduction at Source (TDS) is deducted from the interest payments.

Mode of Holding: Section 54EC Bonds can be purchased and held in the demat form or the physical certificate form.

Eligibility

Resident and Non-Resident Individuals and Hindu Undivided Family (HUF) are eligible to invest in Capital Gains Bonds to claim tax exemption under Section 54EC of the Income Tax Act.

Taxability of Maturity Proceeds

The maturity proceeds of Section 54EC Capital Gains Bonds are tax-free.

Listing in Stock Exchanges

These bonds are issued through private placement and are not listed on any stock exchanges for trading in the secondary market.

Benefits of Investing in Capital Gain Bonds

• Save Tax: Section 54EC capital gain bonds allow individuals and HUFs to save their LTCG tax liability arising from the sale or transfer of land or building after 2 years of their purchase.
• Highest Safety: These bonds are issued by top public sector companies like Indian Railway Finance Corporation Ltd (IRFC), Power Finance Corporation Ltd (PFC) and Rural Electrification Corporation Ltd (REC) having the highest credit rating of ‘AAA’ from SEBI-registered credit rating agencies like ICRA, CARE, CRISIL, etc.

Disadvantages of Capital Gain Bonds

• Long lock-in period: Capital Gain Bonds have a mandatory 5-year lock-in, which limits flexibility.
• Lower returns: Returns on these bonds (5.25% p.a.) are relatively low compared to other investment instruments like corporate bonds, equities, fixed deposits, etc.
• Taxable returns: The interest earned is taxable, further reducing the overall post-tax return.
• Low liquidity: Capital gains bonds are not listed and thereby, not traded in the secondary market. Additionally, these bonds are non-transferable, non-marketable and non-negotiable.
• Cannot be used as loan collateral: Capital Gain Bonds cannot be pledged or offered as security for any loan or advance.

Provisions of Section 54EC 

Section 54EC provides an exemption on capital gains arising from the sale/transfer of a long-term capital asset, being land, buildings, or both. Here are the provisions of Section 54EC:-

• This exemption can be claimed by all assessees.
• The exemption amount will be the lower of the following:

             The amount of capital gains;

             The amount invested in specified bonds; or

             Rs 50 lakh

• To claim exemption, the assessee must invest the capital gains in bonds issued by:-

             National Highway Authority of India (NHAI)

             Rural Electrification Corporation Limited (REC)

             Any other bonds notified by the Central Government

• The investment must be made within 6 months from the date of transfer of the land and/or building.
• The exemption claimed under Section 54EC can be withdrawn in the following situations:

             If the assessee transfers the specified bonds within 5 years, the amount of capital gains that was earlier exempt will become taxable as long-term capital gain in the previous year in which the bonds are transferred.

             If the bonds are converted into cash within 5 years of acquisition, the amount of capital gains earlier claimed as exempt will be taxed as long-term capital gains in the previous year of such conversion.

Eligible Capital Gain Bonds Available for Tax Exemption Under Section 54EC

Rural Electrification Corporation Limited (REC bonds)

Indian Railway Finance Corporation Limited or (IRFC bonds)

Power Finance Corporation Ltd (PFC Bonds)

Who should invest in Capital Gains Bonds or 54EC Bonds in India?

The maturity proceeds of Capital Gains Bonds are not taxable. Thus, taxpayers who do not wish to purchase or construct a new residential property from the capital gains received after the sale of an asset (Land or Building) purchased before 2 years can invest their long term capital gains arising from their property sale in Capital Gains Bonds to save the LTCG tax liability.

How to Calculate the Tax Exemption by Investment in Capital Gain Bonds

Mr. Arjun Mehta sells a long-term residential property for Rs 1.2 crore. His indexed cost of acquisition is Rs 60 lakh. Mr. Mehta invests Rs 50 lakh in REC Capital Gain Bonds within the specified 6-month period. The calculation of tax exemption under Section 54EC is as follows:

Sale Price: Rs 1.20 crore

Indexed Cost: Rs 60 lakh

Long-Term Capital Gain: Rs 60 lakh

Solution: Capital Gain: Rs 60 lakh

Amount Invested in Bonds: Rs 50 lakh

Exemption Allowed: Rs 50 lakh

The remaining Rs 10 lakh (Rs 60 lakh – Rs 50 lakh) will be taxable as long-term capital gain.