Reducing Your Tax Liabilities with 54EC Bonds

Understanding the Benefits of 54EC Bonds for Tax Reduction

As Benjamin Franklin says, in life, only two things are certain: death and taxes. While you can’t control the first, as an investor, you can certainly undertake measures to reduce the latter.

Fixed-income instruments like bonds are one of the most popular investment options for reducing tax liability. By knowing the tax implications of different types of bonds, you can save money on your tax outgoings. For this article, let’s focus on 54EC bonds and how investing in them can help you save on taxes.

Why You Need to Know the Rules of the Game

Taxes are a part of investments, which you cannot escape. As you gain returns on your investment, tax liability knocks on your door. For investments, it is typically capital gains on which you are required to pay taxes.

Capital gains are profits made by you when you sell your investments. It is classified into two parts: Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG). Both these gains have different tax rates based on different time frames as per asset classes

For example, for listed bonds, STCG is applicable as per your tax slab if you sell your bonds within 12 months. On the contrary, for unlisted bonds, the same duration is 36 months. If you sell your investments after these periods, they attract long-term capital gains. The LTCG on listed and unlisted bonds is 10% and 20%, respectively, without the benefit of indexation unless you have invested in government-issued Capital Indexed Bonds or Sovereign Gold Bonds.

In this article, we will take a look at the applicable tax implications on different government and corporate bond categories.

What are 54EC bonds? How do they reduce your tax liability?

Have you recently sold an immovable property, or are you planning to sell one soon? If the answer is yes, you should know the tax liability. If you sell the property within 24 months of purchase, Short Term Capital Gains (STCG) tax is applicable as per your tax slab. If you sell the property after 24 months, you will have to pay a 20% Long

Term Capital Gains (LTCG) tax.

If you want to save tax here, the solution is to invest in 54EC bonds, also known as Capital Gains Bonds. You need to invest the sales proceeds of the property sold in 54EC bonds.

The primary purpose of investing in this bond category is that it offers a 100% LTCG exemption for up to Rs. 50 lakhs. The only condition for this tax benefit to be applicable is if the time between the sale and bond investment is within 6 months and it is a long-term property investment.

A few of the popular capital gains bonds are issued by government-backed infrastructure and infrastructural development companies like Power Finance Corporation Limited and the National Highway Authority of India.

You should note that 54EC bonds provide LTCG exemption only on the invested amount for sale procurements of immovable property. Any gain, typically 5% to 6%, you may receive from investing in these bonds is taxable.

Tax implications on government bonds

There are three popular bonds categorized under government-issued bonds as below.

Government Securities (G-sec) Bonds

G-Sec bonds are debt instruments issued by the government. The interest you earn on this bond is treated as per your tax slab. The STCG and LTCG timeline works the same as we described above. LTCG on listed G-sec is charged at 10% and for unlisted at 20% (with indexation benefits). STCG is again charged as per the applicable tax slab.

Sovereign Gold Bonds (SGBs)

These bonds are issued by the RBI, and the denomination is in grams. SGBs provide you tax exemption and return on your investments along with the value appreciation of gold.

By investing in SGB, you not only get the benefit of investing in gold but also earn a 2.5% return. If you sell your physical gold, you pay 1% TDS, but for SGB, it is 0. Also, the return you receive on investing in this bond is tax-free if you stay invested for the entire 8 years of maturity.

SGBs have a lock-in period of 5 years. If you sell the bond after 5 years, 20% LTCG tax is applicable with cess minus indexation benefits. While if you sell the bonds before 3 years in the secondary market, STCG tax will be applicable as per your tax slab. There is no tax if you hold the bonds for 8 years, which is the maturity term.

Zero coupon bonds

Zero coupon bonds are issued by both government entities and corporations, too. These bonds do not pay you any interest but are issued at a huge discount. So, you invest in these bonds for a lower value and, at maturity, get paid the face value. As there is no interest income, there is no associated tax. However, the capital gain is taxable. For a 12 period, STCG is based on your tax slab. For LTCG, your tax liability is 10%.

Tax implications on corporate bonds

In the case of corporate bonds, you will earn a higher return due to the risk involved. The tax liability on the return you gain on these bonds is the same as a G-sec bond. For the capital gains, any gains over 12 months for listed bonds and 36 months for unlisted bonds are charged at 10% and 20%, respectively, as LTCG tax. STCG, on the other hand, is as per your tax slab.

Zero-coupon bonds, as mentioned above, can also be issued by corporations or companies to raise funds for expansion or projects. The tax implications on these bonds remain the same as the government-issued zero-coupon bonds.

Example of 54EC bonds

Let’s understand the taxation part of 54EC bonds with an example.
Suppose you have sold your old house for Rs. 85,00,000 after 5 years of purchasing it for Rs. 40,00,000. The indexation benefit on the house comes to around Rs. Rs. 50,00,000. To save taxes, you decided to invest in a 54EC bond that offers a coupon rate of 5.5% for 7 years. This is how it will work out.

Sale procures 85,00,000

Indexation on the house cost (-50,00,000)

LTCG invested in 54EC bond 35,00,000

LTCG liability arising from the sale of a house 0

Return on 54EC bond after 7 years 50,90,000 (rounded off)

LTCG on 54EC bond 15,90,000 (50,90,000–35,00,000)

If you have sold the bonds within 36 months, it would have been the case of STCG, and the gains are then added to your annual income.

Thus, the invested amount provides you with an exemption, but the interest earned on that is taxable.

Conclusion

If you have recently sold a property and are looking for ways to reduce your tax liabilities, 54EC bonds, without a doubt, are a great choice.

There is always a benefit when you hold bonds for the long term, as LTCG is taxed at lower tax rates compared to STCG, especially for listed bonds. Hence, even the government encourages investors to go for the long-term and let their money compound and minimize their taxes. You should invest in these bonds based on your goals and risk profile.

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