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All you wanted to know about 54EC bonds

Personal Finance

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A popular option for saving long-term capital gains tax on sale of property is section 54EC bonds. Investing in these bonds can help you make gains of up to ₹50 lakh per financial year from capital gains tax. However, there is a lock-in period of five years. This used to be three years earlier. These bonds carry interest, which is currently at 5 per cent and is taxable.

While these bonds are effective in saving tax, there is another option to consider. You have two choices: (a) save long-term capital gains tax by investing in 54EC bonds and lock in your money for five years or (b) pay the tax, keep your money liquid, and invest it in avenues yielding higher than 5 per cent.

Let us compare the returns from these two options.

Assume, for instance, that there is long-term capital gains of ₹50 lakh that is taxable, after indexation benefit as applicable. A sum of ₹50 lakh invested in 54EC bonds would fetch a defined return of 5 per cent per year. This coupon/interest is taxable at, say, 30 per cent (your marginal slab rate), ignoring surcharge and cess for simplicity. Hence your return, net of tax, is approximately 3.5 per cent. As against this, if you go for option (b), you pay tax on capital gains, which is taxable at 20 per cent if we ignore surcharge and cess, for simplicity. Subsequent to paying the tax of ₹10 lakh, what remains with you for investment is ₹40 lakh. Let us now look at a few options for investing ₹40 lakh.

Tax-free PSU bonds

Since there are no fresh issuances of tax-free PSU bonds and interest rates have eased, the yields available in the secondary market are lower than earlier. For our comparison, we assume a yield (i.e. annualised return) of 4.25 per cent for investing in tax-free PSU bonds. ₹50 lakh invested in 54EC bonds, compounding at approximately 3.5 per cent per year, grows to ₹59.38 lakh after five years. ₹40 lakh, which is the net amount that remains in case of option (b), invested at 4.25 per cent tax-free, grows to ₹49.25 lakh after five years. Hence, investing in 54EC bonds at 5 per cent (pre-tax) is a better option than paying the LTCG tax and investing the remaining amount.

Bank AT1 perpetual bonds

There is a negative perception about perpetual bonds after the YES Bank fiasco. The risk factors that got highlighted after the YES Bank AT1 write-off have always existed, but came into action and hit investors. Having said that, there are front line banks such as SBI, HDFC Bank and the like that are worth investing in.

The range of yields in bank AT1 perpetual bonds is wide. We assume 7.5 per cent to strike a balance between risk (higher yield but higher risk) and reward (lower yield but lower risk). Taxation at 30 per cent means a net return of approximately 5.25 per cent. Against ₹59.38 lakh in case of 54EC bonds, ₹40 lakh invested at 5.25 per cent grows to ₹51.6 lakh after five years. Though somewhat higher than the ₹49.25 lakh from tax-free bonds, this is lower than the ₹59 lakh from 54EC, bonds making the latter a better option.

Equity

It is not fair to compare investments in bonds with equity. However, to get a perspective we will do a comparison. We will talk of the break-even rate now. Let us say, equity gives X per cent return over five years, and that is taxable at 10 per cent, which is the LTCG rate for equity for a holding period of more than one year. If ₹40 lakh invested in equity yields a return of 9.15 per cent per year pre-tax, which is 8.24 per cent net of tax per year, it grows to ₹59.4 lakh after five years. Hence the break-even rate for ₹40 lakh to outperform ₹50 lakh over five years, at 3.5 per cent net of tax, is 8.24 per cent net of tax.

Conclusion

Equity returns are non-defined and the break-even rate calculated for this asset class to outperform 54EC bonds is 8.24 per cent net of tax. It is difficult for bonds as it will be possible only for a bond with inferior credit quality against a AAA rated PSU one. Equity or a riskier bond not being a fair comparison, it is advisable to save the tax and settle for 5 per cent by investing in 54EC bonds. However, liquidity is one aspect you may keep in mind — investment in 54EC bonds is locked in for five years.

The author is a corporate trainer (debt markets) and author

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Tax query: What’s the tax liability for buying resale property using proceeds of equity investment?

Personal Finance

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I am planning to buy a resale property using the proceeds from sale of my shares held in ICICI direct. What will be my tax liability, considering the fact the shares held in the account are one year old to seven-year old? Also, advise me on the precautions needed while buying a resale house.

Nilesh

Assuming that the shares held in ICICI direct are listed on Indian stock exchanges and are held for a period of more than 12 months, the gain/loss arising on sale of these shares shall be treated as long-term capital gain /long-term capital loss (LTCG/LTCL). As per Section 112A of the Act, LTCG in excess of ₹1,00,000 earned from sale of listed equity shares on which securities transaction tax has been paid shall be subject to income tax at the rate of 10 per cent (excluding surcharge and education cess).

Where the shares are purchased before January 31, 2018, the cost of acquisition shall be the higher of the following:

· actual cost of acquisition; or

· lower of (i) fair market value (FMV) of such share on January 31, 2018 (highest quoted price) or (ii) full value of consideration as a result of transfer.

You can explore deduction under Section 54F of the Act in case the net sale consideration arising from the sale of shares is invested in purchase of a residential house property within one year before the transfer date or within two years after the transfer date subject to specified conditions.

In regards to the purchase of immovable property, as per Section 194-IA of the Act, you will be required to deduct taxes at source (TDS) at the time of making payment of the sale consideration to the seller @ 1 per cent (assuming seller is a resident of India), where the sale consideration of the said property is equal to or exceeds ₹50 lakh. In such case, you will also be required to file a TDS return in Form 26QB and issue a Form 16B to the seller of the property.

A senior citizen engaged in businessis expected to make payment of advance tax based on his earnings. I would like to know the following: (i) if a senior citizen makes investment on equity, does he need to pay advance tax based on the quarterly earnings? (ii) if a senior citizen does trading on equity (buying and selling shares) will the same (payment of advance tax) be applicable? Please clarify while keeping in mind long- and short-term gains.

RM Ramanathan

As per Section 208 of the Income Tax Act, 1961 advance tax is applicable if the tax liability (net of taxes deducted or collected at source) on taxable income is ₹10,000 or more. As per Section 207 of the Act, liability to pay advance tax doesn’t apply to a resident senior citizen (who is aged 60 years or more), not having the income from business or profession.

Scenario I

The senior citizen doesn’t have income from business/profession:

Earnings on investment in equity could be in the form of dividend & capital gains (long term or short term, depending upon the period of holding) which are chargeable to tax under the head ‘Income from other sources & Income from Capital gains, respectively.

In view of the provision discussed above, payment of advance tax provision doesn’t apply in this scenario.

Scenario II

Senior citizen derives income from business/profession (trading of shares):

Since the senior citizen is trading in equity (which may include shares held as stock-in trade, intraday transactions etc.), it would tantamount to carrying on a business.

Accordingly, the advance tax provision of section 208 shall apply and he is required to pay advance tax if the net tax liability exceeds ₹10,000 in a FY.

The writer is Partner, Deloitte India. Send your queries to taxtalk@thehindu.co.in

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