Tax Planning and Capital Gains Exemption: Exploring Financial Instruments
With just over a few months left in the current tax year, many of us would already be doing year end tax planning and sussing out options to invest to either gain a tax deduction or tax exemption. We all have Rs.150,000 covered under section 80C in the form of PF or FDs or like. And an additional deduction allowed up to a limit of Rs.50,000 under section 80D. This goes for tax deduction.
However, many of us would be contemplating ways to minimize the capital gains tax (CGT) we must be liable to pay in the current tax year, or look at an exemption up to a certain limit for any CGT applicable. But not many of us might be aware of an investment in a financial instrument which provides an exemption from capital gains tax (up to a cap of Rs.50 lakh).
54EC Bonds or Capital Gains Bonds is one such instrument to consider and know about, which will get you an exemption from the capital gains tax that you might have incurred on a long term asset provided certain conditions are met. Most importantly the taxpayer will have to, within 6 months of sale or transfer, reinvest the proceeds from the sale of a long term asset into a 54EC bond.
Before we go into further details about reinvesting in 54EC bonds, let’s look at what section 54EC of the Income Tax Act talks about.
Section 54EC of the Income Tax Act 1961, exempts a capital gain from any tax implication where “the capital gain arises from the transfer of a long-term capital asset and the assessee has, at any time within a period of six months after the date of such transfer, invested the whole or any part of capital gains in the long-term specified asset, the capital gain shall be exempt from tax under Section 45 as long as the cost of the long-term specified asset is not less than the capital gain arising from the transfer of the original asset”.
Long-term capital assets here include land and/or building. And long-term specified assets, also referred to as 54EC Bonds, includes the following:
- Any bond redeemable after 5 years and issued by the Rural Electrification Corporation Limited (REC)
- Any bond redeemable after 5 years and issued by the Power Finance Corporation Limited (PFC)
- Any other bond notified by the central government
Do note that there is a cap on the capital gain that can be reinvested in a 54EC Bond, and the limit has a ceiling of Rs.50 lakh.
In other words, 54EC Bonds or Capital Gains Bonds are fixed income securities issued by either of: REC, PFC, or any other bond notified by the central government.
Salient Features of 54EC Bonds Investment are listed below:
- Interest income: an investment in 54EC bonds will attract an annual interest income paid at the rate of 5.0%
- Tax implication: exemption from capital gains tax arising from the sale or transfer of long-term capital asset, and exemption of any capital gains tax on the investment in 54EC bonds too. Interest income, on the other hand, is subject to income tax. However, TDS is not deducted and the onus of disclosing interest income is on the individual taxpayer
- Lock in period: the investment in 54EC bonds comes with a lock in period of 5 years, and is non-transferable
- Investment cap: investment limit is capped at Rs.50 lakh, with a minimum investment of Rs.10,000. Each bond is worth Rs.10,000. Hence, a minimum of 1 bond and a maximum of 500 54EC bonds can be invested in
- Eligibility: An individual or HUF are eligible to invest in 54EC bonds
- Credit rating: REC and PFC, both bond instruments carry a rating of AAA issued by CRISIL, ICRA, and CARE.
Better be late than never! Start planning for the tax year end, if you haven’t already.