54EC Bonds: Get Paid To Save Tax

One of the ways of saving tax on long-term capital gains is by investing in the bonds issued by NHAI or REC. This deduction is under Section 54EC of the Income Tax Act. The maximum limit for such investment in any financial year is Rs 50 lakh. Since the main function of these bonds is tax saving, the interest rate on offer is a modest 6% per annum. 

It is on account of this low interest rate that many investors opt to pay the entire amount of tax and invest the balance in shares or quality equity funds. Their 
reasoning is on the following lines—while it is true that investing in the bonds could save them tax, the bonds per se offer very little, that too fully taxable. Plus, the money is locked-in for three years.  Wouldn’t it be a better idea instead to pay the tax and earn good returns with the remaining money? To find out, we decided to run some numbers. The analysis threw up some fascinating results.

The Analysis

Here’s what we found. If you have earned long-term capital gains, the Sec. 54EC bonds is one of the best investments you could make. This is despite the fact that the returns are low, in spite of the fact that the interest is taxable and in spite of the fact that there is a three-year lock-in. Why? Examine the following table.

The key thing is that on account of tax saving, the bonds effectively help the investor save tax up to 20% which is otherwise incurred on sale of property.

For example, in the table below, say the investor has earned a capital gain of Rs 100. Effectively, he will end up investing Rs 80 in the bonds as he saves a tax of Rs 20. At the rate of 6%, he earns Rs 6 every year, and at the end of three years, he gets his original investment back.

The net equivalent return works out to an eye popping 12.60% p.a after tax! And if the investor does not have other taxable income, the return climbs to 14.70% p.a! Any which way you look at it, investing in these bonds is like getting to save tax and also gettin paid for it! One should definitely go for it.

The earlier idea was to pay tax and take the remaining funds to greener pastures. Therefore we thought it could also be interesting to see how green the pasture should ideally be.

Let us say one is to invest Rs 1 lakh in the market. At the rate of 14.70% p.a over three years, the money should grow to around Rs 1,51,000, i.e., almost 50% more. And this is just to break even. It is after that, that the investor will actually start making any money.

July 31   Rs (Pre-tax). Rs (Post-tax)
  Amount of long-term capital gains 100 100
  Tax Saved on account of investment 20 20
2011 Net effective amount invested in the bonds 80 80
2012 Interest earned for the first year 6.00 4.20
2013 Interest earned for the second year 6.00 4.20
2014 Interest earned for the third year 6.00 4.20
2014 Maturity amount 100 100
  Equivalent Rate of returns 14.70% 12.60%

Sec. 54EC: Rs 50 lakh limit

It may be noted that these Sec. 54EC bonds may be used to save tax on any long-term capital gain and not necessarily that from sale of property. For example, 54EC Bonds: Get Paid To Save Taxapart from property, sale of non-equity mutual  funds, bonds, debentures, gold jewellery or even gold ETFs etc. may result in longterm capital gains. Such gains may be saved by investing the gain amount in the 54EC bonds as detailed above.

There is only one drawback to these bonds—the maximum investment in any one financial year is capped at Rs 50 lakh. While by no means a small amount, the way property prices have spiralled, some investors do find it not enough to cover the entire amount of capital gains.

However, smart planning will come to your rescue. Remember, one has six months to invest in the bonds from the time of earning the capital gain. If one 
found that he or she would need a tax cover of more than Rs 50 lakh, then the sale transaction could be timed between December and March of any year. This way, the six month period overlapped two financial years which would in turn enable the investor to double the investible amount to Rs 1 crore (Rs 50
lakh for each financial year.) But Budget 2014 plugged this loophole and now, a maximum of Rs 50 lakh only may be invested for any transaction. 

Posted by The Finapolis Friday, April 17, 2015 2:52:00 PM


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