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54EC Bonds: Use These Optimally

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 Sec. 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 the tax deduction, the interest rate on offer is a modest 6% p.a.

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 amount is locked in for three years. Wouldn’t it be a better option, to pay the tax and earn good returns with the remaining amount?

To find out, we decided to run through some calculations. The analysis threw up some fascinating results to share with our readers.

The Analysis

Here’s what we found. If you are lucky enough to have earned long-term capital gains, the Sec. 54EC bonds is one of the best investments you can opt. Despite the fact that return is low, the interest is taxable and it has a three year lock-in.

Examine the following table. We assume that the asset has been sold on 31st July 2012. The rest is self-explanatory.

Date Particulars Rs (Pre-tax) Rs (Post-tax)
  Amount of long-term capital gains 100 100
  Tax Saved on account of investment 20 20
31st July 12 Net effective amount invested in the bonds 80 80
31st July 13 Interest earned for the first year 6.00 4.20
31st July 14 Interest earned for the second year 6.00 4.20
31st July 15 Interest earned for the third year 6.00 4.20
31st July 15 Maturity amount 100 100
  Equivalent Rate of returns 14.70% 12.60%

(Tax rate assumed to be 30%, surcharge & cess has been ignored for simplicity)

The key thing is that on account of the tax saving, the bonds effectively offer the investor an up-front 20% discount. It is like investing Rs 80 but earning a return on Rs 100. Also the 20% gets spread over just three years which is the lock-in period of the bonds.

For example, in the table, 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 get paid for it!! One should be crazy not to go for it.

As discussed earlier, the idea of many investors is 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 exactly be.

Lets say one were to invest Rs one lakh in the market. At the rate of 14.70% p.a over three years the money should grow to around Rs 151,000 i.e. almost 50% more. And this is just to break even. After that the investor will actually start making any money.

Sec. 54EC: Rs 50 lakh limit

Last but not the least, it may be noted that these Sec. 54EC bonds may be used to save tax on any long-term capital gain and not necessarily only from sale of property. For example, apart from property, sale of say non-equity mutual funds, bonds, debentures, gold, jewellery or even gold ETFs etc. may result in long-term capital gains. These gains can be saved from taxes by investing the amount in the 54EC bonds as discussed.

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

However, some smart investors found a loophole in Sec. 54EC and they took an advantage for investments in such bonds. Remember, one has six months to invest in the bonds from the time of earning the capital gain. So for instance if an investor needs a tax cover of more than Rs 50 lakh. Then he would time the sale for transaction between December and March of any year. In this way, the six month period overlapped two financial years which would in turn enable him (investor) to double the investible amount to Rs 1 crore. However, budget 2014 has plugged this loophole and now a maximum of Rs 50 lakh only may be invested for any transaction.

Written By: AN Shanbhag and Sandeep Shanbhag (The authors are leading financial advisors. Write to them at

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