Capital gains are the taxes that assessee must pay on the gains made from sale of capital assets. Under the Income Tax Act, capital assets are assets like:
• Jewellery
• Gold
• Precious metals
• Precious stones
• Paintings
• Equity shares
• Mutual funds
• Debentures
• Derivatives
• Any other assets invested not as a part of business
The distinguishing point of a capital asset is that the person does not make an investment in the capital asset for the purpose of trade but to earn a return from an increase in value.
The capital gain tax is paid to the Government based on the period of holding of the capital asset. It can be either long term capital gains or short term capital gains. However, Section 54 of the Income Tax Act deals with exemptions from capital gains earned by the assessee.
One of the ways to reduce the capital gains is by investing in capital gain bonds. This is governed by Section 54EC of the Income Tax Act. Under this section, the amount invested in tax free NCD or bonds gets a deduction for the purpose of capital gains.
Some of the companies that issue bonds under Section 54EC are:
• Rural Electrification Corporation (REC)
• National Highways Association of India (NHAI)
Any investment made in these bonds gets a deduction from the capital gains amount. The calculation is as follows:
Sale Value xxx
Less: Cost of acquisition (xx)
Less: Cost related to purchase (xx)
Capital Gains xxx
Less: Investment under Section 54EC (xx)
The coupon rate for these bonds is fixed at 5.75%. the maximum investment that can be made in Section 54EC bonds is Rs. 50 lakhs. However, the maximum amount of deduction available in this section is restricted to the amount of capital gains. If an amount lesser than the capital gains amount is invested in these bonds, a proportional deduction will be given from the capital gains.
The minimum amount of investment in these non-convertible debentures is Rs. 10,000. There are a few more conditions with regards to this investment:
• The exemption is allowed in case the funds are invested in Section 54EC within 6 months of the date of transfer
• The investment in Section 54EC is held for a period of 5 years
The interest earned on these NCD is taxable under the income tax act based on the slab rate of the assesses. From Budget 2018, these bonds will only help to reduce the capital gains in case the asset is land and building. This means gains made on other capital assets will not be reduced.
While considering the impact of capital gains, it is important to understand a few factors:
• The quantum of capital gain tax on the investment
• The lock in period for capital gain bonds
• The return on other sources of investments
• Liquidity requirements
Since it is possible to get a deduction under Section 54EC of the Income Tax Act up to 6 months after sale of the capital asset, it is important to assess these factors to understand whether making an investment in Section 54EC bonds is the best option. Taking a well-informed decision will help in both tax planning and in improving earnings.