Sec 54EC - A smart way to save capital gains tax

Section 54EC of Income Tax Act, 1961 provides that Capital Gain arising from the transfer of long-term capital asset being land or building or both shall not be charged to tax in case the amount of capital gain is invested in Capital Gain Bonds. This Section has been amended recently by Finance Act, 2018 whereby lock-in period of investment in capital gain bonds has been increased from 3 years to 5 years.

Further, the benefit of this deduction has been restricted to Long Term Capital Gains (LTCG) arising from the transfer of land or building or both.

Entities which issue capital gain bonds

As on date, there are four entities (all ‘AAA’ rated) which are empowered to issue Capital Gain Bonds :

• Power Finance Corporation Limited (PFC),
• Indian Railway Finance Corporation Limited,
• National Highways Authority of India, and
• Rural Electrification Corporation Limited

Now let’s look at whether investing in capital gain bonds is a smart move to save taxes, considering the coupon rate on these bonds is currently 5.75% p.a and there is a lock-in period of 5 years. 

LTCG arising from the transfer of land or building or both if invested in capital gain bonds specified under section 54EC of the Income Tax Act, 1961 are exempted from tax. However, in order to claim the deduction, one needs to invest in these bonds within 6 months from the date of the transfer of capital asset. Further, the maximum amount of LTCG that one can invest in these bonds is Rs 50 lakh.

Thus, in case the amount of LTCG works out to Rs 60 lakh,  one would be able to save tax on Rs 50 lakh by investing in capital gain bonds. However, in case of the jointly held real estate, each owner has a separate limit of up to Rs 50 lakh for investing in these bonds.

If one decides to invest in 54EC bonds, it will fetch a return of 5.75% p.a. (which will be taxable at the applicable slab rate of the taxpayer) but one will be able to save LTCG tax of Rs. 10,40,000 (LTCG rate of 20.8%) in the first year itself. Thus, the effective post-tax return works out at 9.35% (considering the highest marginal tax rate of 31.2%).

In case one decides to pay LTCG tax and invest the net amount of Rs. 39,60,000 (Capital Gain of Rs. 50,00,000 - LTCG of Rs. 10,40,000) in other fixed-income securities, for earning the same post-tax return of 9.35%, the securities would need to pay interest rate of around 13.5%, which is currently not being offered by any Government entity / ‘AAA’ rated issuer(s).

One could also look at investing in mutual funds, but the returns thereof are not guaranteed as they are subject to market risks.

Hence, investment in Capital Gain Bonds would be a smart move if one wants to save LTCG tax, avoid market risk and earn a fixed return on investment.