What is Section 54EC bonds and how do they work?

Posted by aarav badhe on February 15th, 2020

The Government charges income tax on a wide variety of incomes like salary, rental income, business income, interest income. Apart from this, there is a tax on assets that are purchased and sold by the individual.

Capital gains are the taxes that assessee should pay on the gains made from sale of capital assets. Under the Income Tax Act, capital assets are assets like jewellery, gold, paintings, shares, mutual funds, motor cars, precious stones etc that are not 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. This section helps to reduce the taxable income for the purpose of the act.

One of the ways to reduce the capital gains is by investing in capital gain bonds. Section 54EC of the Income Tax Act deals with this deduction. Any amount invested in specified capital gain bonds gets a deduction for calculating capital gains. The total amount of gain is reduced by the investment made in these bonds.  

Some of the companies that issue bonds under Section 54EC are:

•    Rural Electrification Corporation (REC)
•    National Highways Association of India (NHAI)

It is important to remember that these are specified bonds. Not all bonds give this exemption. This is important to understand because 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. Apart from this, here are a few things to know about 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 assessee. From Budget 2018, these bonds will only help to reduce the capital gains in case the asset is land and building. This means there is no exemption for capital gains on other assets.
 
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, you need to figure out whether investing in bonds makes more sense than paying capital gain tax on the gains. After making this calculation, you can decide the amount to invest in these bonds.