One of the most legitimate ways to save capital gains taxes is by investing in capital gains tax exemption bonds to save on the long-term capital gains arising from the sale of the property. This is covered in its entirety under Section 54EC of the Income Tax Act, India 1961. Here we understand the nuances of section 54EC and how it could benefit an individual with long-term capital gains arising from the sale of the property.

What are 54EC bonds?

These bonds are also called capital gains bonds they are the ideal way to save on the long-term capital gains tax. They are meant only for those individuals who have long-term capital gains arising out of the sale of property and would like to claim exemption on capital gains for Income Tax purposes.

The tax exemption U/S 54EC of the Income Tax Act 1961, is not available on short-term capital gains, they are specifically available for long-term capital gains which arise from the sale of the property. The maximum limit for investing in 54EC bonds is adjudged at Rs. 50 Lakh.

There are many bonds which are eligible under this scheme – IRFC (Indian Railways Finance Corporation Limited) NHAI i.e.  National Highways Authority of Indi), REC (Rural Electrification Corporation Ltd.), and PFC i.e. Power Finance Corporation Ltd.

When is this tax exemption applicable?

This exemption applies only to long-term capital gains arising from the sale of a capital asset such as land, building or both. The assessee is required to invest the gain in its entirety at any time within 6 months from the date of such transfer of asset. The extent of the amount invested can be claimed as a tax exemption.

The following two provisions have been mentioned regarding the capital gain arising from the long-term specified asset:

  • If the purchase price or cost of the long-term specified asset is not lower than the quantum of capital gain, then the entire amount will not be charged under section 45
  • If the purchase cost of the long-term specified asset is lower than that quantum of capital gain, then the remaining amount will be charged under section 45.

Features of 54EC bonds:

Some of the key features of 54EC bonds are:

  1. The minimum amount of investment is Rs. 10,000 which is the cost price of 1 bond, the maximum bond that can be availed is limited to 500 bonds, thereby stipulating the maximum limit to Rs. 50 lakhs.
  2. The returns generated from this asset are in the form of interest rate, stipulated at 5% and payable annually. It was reduced from the previous interest rate of 5.575% p.a with effect from July 2020.
  3. The interest on the bond will be included in total income and will be taxed at normal rates, alongside other sources of income.
  4. The amount invested in these bonds is subject to a lock-in of 5 years from the date of acquisition. If the specified asset is withdrawn or transferred within 5 years, then the amount would be subject to capital gain taxes.
  5. If the assessee avails any loan or advances against the long-term specified asset, it shall be “deemed to be converted”, by means other than transfer, if the same is done within 5 years, then the tax benefit is reversed in the same year in which the loan or advance is availed.

Understanding the practical implication:

The sale of residential property which includes land, house or apartment within 2 years is assessed under short-term capital gains, after a holding period of 2 years, the gain is assessed under long-term capital gains. The STCG is taxed at a normal tax rate, and LTCG is taxed at 20.6% with an indexation benefit. The indexation benefit provides adjustment for inflation. This boosts the purchase price and brings down the tax liability. The capital gains so calculated when invested in 54EC bonds will help the assessee avoid payment of taxes on the gains.

54EC bonds are a boon in disguise to save on taxes arising out of capital gains upon the sale of a property. You can reach out to our experts at Tata Capital to help you comprehensively plan your taxes.

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