Which Capital Gains Bonds are presently available?

Question

I want to invest in Capital Gains Bonds to save Tex on my Capital Gains. But I learn that NO such Bond is presently available from any Bank or Financial Instituition AND no Auditor seem to know when some kind of Bond shall be made available. Please inform where I can invest to save on Long Term Capital Gains Tax?

Answer 1

http://incometaxindia.gov.in/UnderstandingIT/CapitalGains.asp#Exemption

(e) Section 54EC: This section has been introduced from assessment year 2001-2002 onwards. It provides that if any long term capital asset is transferred and out of the consideration,investment in specified assets(including bonds isssued by National Bank for Agricultural & Rural Development or by National Highway Authority of India or by Rural Electrification Corporation is made within 6 months from the date of transfer, then exemption would be available as computed in Sec. 54F.

(f) Section 54ED: This section has been introduced from assessment year 2002-03 onwards,. It provides that if a long term capital asset, being listed securities or units, is transferred and out of the consideration, investment in acquiring equity shares forming part of an eligible issue of capital is made within six months from the date of transfer, then exemption would be available as computed in Sec. 54F.




Managing a capital gains tax liability can be quite a handful for assessees. The conventional method of dealing with such a liability is to simply invest in capital gains bonds. At Personalfn, we believe there is more than one way of doing this.

However, before discussing the various alternatives, let us understand what a capital gains liability is and how it arises.

If you sell any capital asset (like a house property), a capital gains tax liability can arise on the same. If the asset (property in this case) has been sold within 36 months from the date of purchase, it amounts to short-term capital gains. Conversely, if the asset is held for a period of more than 36 months, a long-term capital gain arises.

In case of assets like mutual funds, the holding criterion for determining long-term or short-term is reduced to 12 months. So if you hold the security for over 12 months, it qualifies for a long-term gain.

The following illustration explains how a capital gains are computed.

Table 1
Cost of Purchase (Rs)
1,500,000

Sale Proceeds (Rs)
3,000,000

Date of Purchase
01-Mar-95

Date of Sale
01-Mar-05

Cost Inflation Index for the year of purchase
259

Cost Inflation Index for the year of sale
480

Sale Proceeds (Rs)
3,000,000

Less: Indexed Cost of Purchase (Rs)
2,779,923

Long-term capital gains chargeable to tax (Rs)
220,077

Long-term capital gains tax @ 20%
44,015


Suppose you purchased a house property in March 1995 at a cost of Rs 1,500,000 and sold the same 10 years hence at Rs 3,000,000. Your profit on sale would be Rs 1,500,000. However for the purpose of computing capital gains, the purchase price has to be adjusted for inflation using the Cost Inflation Index (see Table 1).

The long-term capital gains will now amount to Rs 220,077. At a tax rate of 20% (for long-term capital gains), the tax liability amounts to Rs 44,015.

Now let us examine the various options available for managing the capital gains liability.

1. Invest in capital gains bonds

Assesses have the option of not paying any long-term capital gains tax by investing the profit (Rs 220,077) in capital gains bonds with a stipulated time period. Capital gains bonds are issued by specified institutions and tax benefits are available under Section 54EC of the Income Tax Act.
How to smartly invest Rs 1 lakh to save tax
The 2006 Guide to Tax Planning

For the purpose of claiming tax benefits, investments should be made within a period of 6 months from the date when the capital asset was sold. Similarly, investors are required to stay invested in the bonds for a period of 36 months from the date of investment. Redemption before completion of the 36-month period will negate the tax benefits.

Table 2 demonstrates the working on capital gains bonds. NABARD offers capital gains bonds with a coupon rate of 5.50% for a 5-year period. Investors have the option of liquidating their investments at the end of 3 years without affecting the tax benefits claimed.

Table 2
Long-term capital gains (Rs)
220,077

Tax saved at time of investing (Rs)
44,015

Effective amount invested (Rs)
176,062

Coupon rate
5.50%

Tenure (years)
3

Maturity proceeds (Rs)
246,252

3-year CAGR returns*
11.83%


(*Returns adjusted for tax benefits)

Since investing in capital gains bonds entails not paying any long-term capital gains tax, the net amount (long-term capital gains less tax liability on the same) has been used for computing the returns. Similarly, interest earnings from the capital gains bonds are assumed to be taxed at the highest tax slab (30%, plus 2% for education cess).

In the above example, the investor would earn returns at 11.83% CAGR over the 3-year period. This option will appeal to investors with a low risk appetite and to those for whom not paying tax is a high priority.

2. Pay the tax and invest in other avenues

If you are not happy with the idea of locking away your gains in capital gains bonds for a 3-year period, you can explore the possibility of paying the capital gains tax liability and investing the balance in alternate avenues like mutual funds.

Table 3 lists returns clocked by some leading diversified equity funds and balanced funds.

Table 3


3-year*

Diversified Equity Funds


HDFC Top 200
66.33%

Franklin India Bluechip
59.91%

Sundaram Growth
55.55%

Balanced Funds


HDFC Prudence
53.89%

DSP ML Balanced
42.79%

FT India Balanced
37.64%


(Source: Credence Analytics; NAV data as on November 11, 2005. *Returns are Compounded, Annualised.)

Clearly the mutual fund schemes under consideration have clocked far superior returns vis-à-vis the capital gains bonds as seen in Table 3. However, equity-oriented schemes are high-risk investment avenues and expose investors to considerably higher levels of risk as compared capital gains bonds.

Secondly, unlike capital gains bonds, mutual funds don't offer assured returns. Finally the returns listed above are historical in nature.

While it would be difficult to predict how the equity markets will behave over the next 3 years, we believe a 15% CAGR return over this time frame seems like a reasonable one. Equity-oriented funds if held for a period of more than 12 months are exempt from any long-term capital gains tax liability; also dividends received from such funds are totally exempt from tax.

In such a scenario, investors will be better off paying tax and investing the balance in mutual funds rather than investing in capital gains bonds.

Table 4
Long-term capital gains (Rs)
220,077

Less: Long-term capital gains tax paid (Rs)
44,015

Net amount invested (Rs)
176,062

3-year returns*
15.00%

Tenure (years)
3

Maturity proceeds (Rs)
267,768


(*Returns are Compounded, Annualised.)

3. Invest the gains in a residential house property

Section 54 and Section 54F of the Income Tax Act contains provisions whereby long-term capital gains can be utilised to acquire/construct a residential house property. If the necessary conditions (including the time frame within which the gains must be invested for buying/constructing a property) are fulfilled, the assessee is exempt from paying capital gains tax.

As in the case of capital gains bonds, the property acquired should not be transferred within a 3-year period from the date of transfer or construction; failure to adhere to the same will negate the tax benefits claimed.

As we had mentioned earlier, capital gains bonds are not the only means for managing your tax liability. Your decision to invest in capital gains bonds or otherwise should be determined by your risk appetite and investment objective among others.

For example, if you are content with the idea of a low-risk but assured-returns investment avenue, coupled with the prospect of not paying any tax, capital gains bonds are your calling. Alternately, you can consider paying up your tax liability and using the mutual fund route.

The key lies in being aware of the various options and making an informed choice.

Answer 2

Currently only Capital Gain Bonds issued by NHAI or REC are available. (section 54EC) as amended by Finance Act, 2006.

see link below:
http://www.indiantaxsolutions.com/main.php?t=28011995&d=1152594047

Reproduced:

Exemption under Section 54EC for investment in capital gains bonds - extension of time frame demystified .

Sec. 54EC grants deduction from taxable capital gains on transfer of a capital asset to the extent of investments in notified bonds within six months from the date of transfer of such asset.
There has been an amendment to Sec. 54EC restricting the available bonds to those issued by the National Highways Authority of India and Rural Electrification Corporation with effect from April 1, 2006. These bonds were also required to be notified so as to take effect from April 1, 2006.

Those who had not made the investments before March 31, 2006, though the permissible time of six months had not expired by that date, were in for a shock because the new bonds were not notified on April 1, while the old bonds were ineligible under Sec. 54EC on or after April 1, 2006.

Those who had invested before March 31, even before the expiry of six months, in the earlier bonds will have no difficulty. But for those for whom the time limit was expiring without the new bonds being available, it was expected that along with the notification of the new bonds, the Board would also relax the time limit for reinvestment, so that the taxpayers do not lose the concession merely because of the delay in notification. This hope has not been belied in the long-awaited notification vide No. 142 and 143 of 2006 dated June 29, 2006.

A Press note issued by the Press Information Bureau dated June 30, 2006, refers to these notifications, which extend the time limit for re-investment in the new bonds, removing the hardship arising out of delayed notifications, by relaxing the time limit by exercise of the power vested in the Board.

The Board has now issued an order under Sec. 119(2)(c) extending the time limit for making investments for the two classes of persons as indicated below:

1. Those who had transferred a long-term capital asset between September 29, 2005, and December 31, 2005, that is, where the capital gains arose in calendar year 2005 after September 29, 2005, can make investments up to September 30, 2006. They are getting the extended time irrespective of the fact that six months' period from the date of transfer might have expired.

The choice of the date September 29, 2005, is apparently because any sale prior to this date would mean that the period of six months had expired even by March 31, 2006, before the restriction had set in.

2. Those who had transferred the long-term capital asset between January 1, 2006, and June 30, 2006, can invest in these bonds till December 31, 2006. In other words, the time available for those, who had transferred the capital asset on January 1, 2006, will be December 31, 2006, same as for those transferring on June 30, 2006.

Both extensions are therefore even more liberal than what is strictly warranted by the delay in issue of notifications.

But then, there is a risk of the bonds not being available after some time, if taxpayers delay their investments.

This is because the notification for the National Highways Authority of India limits the issue to Rs. 1,500 crore, while for bonds issued by the Rural Electrification Corporation, the limit is Rs. 4,500 crore.

Once the collections made by them cross the limits, further investment in these bonds will not be possible, so that this relief will not then be available. It is for this reason that the application from the Rural Electrification Corporation clearly provides that these bonds issued on a private placement basis have a ceiling of Rs. 4,500 crore during the financial year 2006-07, so that excess subscriptions will not be accepted. Excess subscriptions received will be returned with interest at 5.5 per cent.

If a taxpayer merely deposits the amounts through banks or any of the branches and it is later found that the limit has been exceeded, he will be losing the benefit of this deduction under Sec. 54EC.

Obviously, the available bonds will be issued on a first-come-first-served basis. The notifications cover only bonds issued during 2006-07, so that those who have capital gains after October 1 will have to make sure that they subscribe to the bonds, if they are still available even before the expiry of six months.

In view of these constraints, the benefit of Sec. 54EC may not be available for all as it makes it available for a limited period.

The application form has another problem already highlighted in these columns. Nomination is provided only for individuals, while application is entertained from Hindu Undivided Families as well.

In the event of the karta pre-deceasing the date of maturity, there is the problem of redemption. It is necessary that in such cases the application form provides for details of other coparceners, so that the maturity amount may be paid to others collectively or on authorisation from them to anyone of the coparceners.

Otherwise, the Hindu Undivided Families will have difficulty in redeeming the bonds making the two institutions beneficiaries of any delay in redemption, since there is no provision for payment of interest in such cases after the date of redemption.

By S. RAJARATNAM