Section 54EC- Deduction on LTCG Through Capital Gain Bonds

Prudent and sound financial management of long-term capital gains (LTCG) is a prominent aspect for several taxpayers particularly in the light of updates issued in the Budget of 2024.

The Finance Minister of India, Nirmala Sitharaman proposed notable changes, including an increase in the tax rate for short-term capital gains from 15% to 20% and a revised rate of 12.5% (bumped up from 10%) for long-term capital gains, which is applicable on financial as well as non-financial assets. In addition to this, the tax exemption limit on LTCG has been extended to ₹1.25 lakhs, offering some relief to taxpayers.

With capital gains bonds 54EC, investors can take advantage of an effective way to reduce their LTCG liability. Capital gains bonds 54EC enables taxpayers to reinvest their gains and claim tax deductions. These bonds provide secure returns, making them particularly appealing to risk-averse investors. The 54EC bonds’ interest rate is an important consideration for investors offering a reliable and predictable income stream while aligning with tax-saving goals.

Let us dive into Section 54EC of the Income Tax Act in better detail.

Any property or asset owned by an individual can be classified as a capital asset regardless of whether it is for business or personal uses. These assets can assume various forms including tangible items such as vehicles, land, and buildings as well as intangible assets such as trademarks and debentures. These capital assets can further be classified into short-term and long-term, depending on their respective holding periods.

-Short-Term Capital Assets: Assets that are held for less than three years (or one year in the case of equity shares and equity-oriented mutual funds) are classified into short-term assets. When these assets are sold, the returns are in short-term capital gains, and are taxed at higher rates when compared to long-term gains.

-Long-Term Capital Assets: Conversely, assets held for over three years (or 12 months for specific financial assets such as equity). The sale of these assets yields long-term capital gains that qualify for tax-saving benefits under certain provisions. The deduction under Section 54EC is one such provision that enables taxpayers to save on their taxes.

Section 54EC of the Income Tax Act enables taxpayers to re-invest their long-term capital gains into specified bonds to claim a deduction. These 54EC bonds include those that are backed by government entities, thereby offering a reliable investment option.

The returns on these bonds that are governed by the 54EC bonds interest rate, provide a steady stream of income, making them an attractive wealth-creating option for the risk-averse. However, these bonds come with a mandatory lock-in period of five years, during which they cannot be transferred or used as collateral.

Leveraging these provisions enables taxpayers to minimise their tax liabilities while investing in safe, government-supported instruments.

Under Section 54EC of the Income Tax Act, taxpayers are afforded a viable option to save on long-term capital gains (LTCG) tax by reinvesting their gains into specific bonds. These LTCG bonds, or as they are commonly known - 54EC bonds, are fixed-income instruments that provide a reliable investment option while ensuring tax exemption for eligible taxpayers.

However, to claim this exemption, investors are expected to meet certain conditions. The taxpayer must invest the LTCG from the sale of immovable property (for instance land, building, or both) within the specified 54EC bonds time limit. This limit is six months from the date of transfer of the asset. Eligible bonds comprise ones that are issued by government-backed entities such as the:

• National Highways Authority of India (NHAI)

• Rural Electrification Corporation (REC)

• Power Finance Corporation Limited (PFC) and

• Indian Railway Finance Corporation (IRFC)

For the aforementioned bonds, the total investment has been capped at ₹50 lakh through the financial year of the transaction and the subsequent one.

The bonds cannot be sold off for a minimum lock-in period of five years, during this period, the investor is not permitted to transfer, convert, or use the bonds as collateral for loans. If these limitations are not complied with, it causes a loss in tax exemption.

In addition to the tax-saving benefits, these bonds offer fixed returns, making them an attractive investment for the risk-averse. The 54EC bonds’ interest rate is generally determined by the issuing authority and is competitive, providing investors with a steady stream of income. For retired individuals, the 54EC bonds’ interest rate for senior citizens is especially interesting as it promises reliable earnings in the post-retirement phase. In addition to this, it also offers tax-saving benefits.

Section 54EC is ideal for individuals, HUFs, companies, LLPs, and other entities looking for ways to efficiently manage their LTCG liabilities. By making their investment in these LTCG bonds, investors can not only balance their tax obligations with financial security but also make it a wise choice for those selling long-term capital assets such as buildings and land.

The 54EC section of the Income Tax Act provides individuals a structured way to save taxes on their long-term capital gains by offering them an opportunity to reinvest these gains in specific government-approved bonds, which are typically known as 54EC bonds. When availing of this exemption, here are some facts to bear in mind:

Investment Deadline:** To avail of this exemption, the capital gains must be reinvested within the prescribed 54EC bonds time limit. This deadline is six months from the time of the sale of immovable property. Investors must be wary of this timeline if they expect to avail of tax exemption.

-Lock-in Period: Investments made in 54EC bonds come with an obligatory lock-in period of five years. Before April 2018, these bonds were redeemable after a period of three years, however, the lock-in period has since been extended to encourage long-term financial planning.

-Eligible Gains: The exemptions are available exclusively for LTCG resulting from the sale of immovable property. This includes lands, buildings, or both. Gains received from any other asset categories are not eligible.

-Investment Cap: The maximum investment that is permissible under these bonds is capped at ₹50 lakh per financial year. This premises an equitable distribution of tax benefits.

-Fixed Returns: The 54EC bonds’ interest rate is determined by the respective issuing authorities and offers a steady return, making these bonds appealing to those seeking low-risk investment avenues.

By adhering to these aforementioned guidelines, taxpayers can efficiently reduce their LTCG liability while benefiting from a secure investment avenue that is backed by government entities.

Under Section 54EC of the Income Tax Act, taxpayers can save on their long-term capital gains (LTCG) by reinvesting their gains under specified government-backed bonds. Let’s dive into this through detailed examples to showcase how this tax exemption works.

Sec 54EC of Income Tax Act with Example

-Example: Consider that an individual sells their residential property valued at ₹95 lakh after holding it for 48 months (four years). The indexed cost of acquisition is ₹40 lakh, and the indexed cost of improvement is ₹15 lakh.

The indexed cost of acquisition and indexed cost of improvement play a prominent role in adjusting the original purchase price of the property and the improvement costs for inflation. These adjustments make sure that the taxpayer takes into account the increasing cost of living over the asset’s holding period, thereby reducing their taxable gains.

In the above example, consider that the taxpayer decides to reinvest a portion of the LTCG into 54EC bonds within the notified 54EC bonds time limit of six months.

Case 1: The seller invests ₹30 lakh in REC bonds within 6 months

In the above case, by investing ₹30 lakh in REC bonds, the taxpayer has reduced their taxable LTCG to ₹10 lakhs. When calculated:

Tax on LTCG: 10,00,000 x 20% = ₹2,00,000

Cess (4% of ₹2,00,000): 2,00,000 x 4% = ₹8,000

This means, the total payable tax = 2,00,000 + 8,000 = ₹2,08,000

Case 2: The seller invests ₹50 lakh invested in NHAI bonds within 6 months

In the above case, the taxpayer has reinvested their entire LTCG into NHAI bonds, thereby reducing their taxable income to zero. It is important to note, however, that the taxpayer can only invest up to ₹50 lakh in a financial year under Sec 54EC of the Income Tax Act. In other words, an amount that exceeds this cap would not be eligible for exemption.

Taking a look at Sec 54EC of the Income Tax Act with an example helps us understand the provision better.

Despite the fact that the 54EC bonds are not listed on the stock exchange, investing in them is a relatively straightforward process. These bonds can be accessed directly from the issuers either in dematerialized (demat) or physical form.

Here is a step-by-step guide to help you invest in capital gains bonds 54EC:

-Step 1: Download the application form

Visit the official portals of the respective bond issuers such as REC bonds, PFC bonds or IRFC bonds to access the application form.

On the download page, select the “Direct” option.

Enter the necessary details, such as the number of forms to download.

Enter the captcha code as presented on the screen and initiate the download.

-Step 2: The downloaded form will be available in ZIP format. Unzip the file, and print your relevant form. Carefully follow the instructions that have been provided and accurately fill out the required details.

-Step 3: Investors will then need to enclose the demand draft or account payee cheque for the investment amount. Ensure that the attachments comprise all the relevant documents. Once these documents have been collated, submit them to designated branches such as Yes Bank, SBI, Axis Bank, Canara Bank, ICICI Bank, IDBI Bank, IndusInd Bank, or HDFC Bank.

-Step 4: Conversely, investors can deposit the investment amount directly into the collection account of the issuer through NEFT or RTGS. Once the funds have been transferred, accurately fill out the application form online and ensure you include the UTR (Unique Transaction Reference) number in the designated field.

-Key Factors to Consider:

Ensure that you carefully store all copies of the forms that have been filled out as well as the proof of payment for reference.

To avoid any delays in processing, ensure all details have been verified before submission.

This simple process ensures a hassle-free experience of investment in 54EC bonds, enabling taxpayers to claim deductions on LTCG while benefiting from reliable, government-backed instruments.

In addition to being a tax-saving mechanism, 54EC bonds also offer practicality when it comes to long-term financial security. These bonds are backed by government entities and provide a combination of reliability and simplicity, making them a captivating choice for various tax-payer profiles. Here are some unique takeaways to consider:

Encourages Long-Term Financial Discipline: The mandatory five-year lock-in period instils the discipline of saving ensuring investors align their strategies with long-term financial goals.

Risk-Free Investment Option: As these bonds are issued by trusted entities such as REC, PFC, NHAI, and IRFC, they provide a stable way to preserve and build capital in a risk-averse manner. It is an ideal option for those seeking stability in their investment portfolios.

Market Stability: Unlike investments in mutual funds or equity, 54EC bonds are protected from market volatility, providing a predictable stream of income, and thereby offering peace of mind.

Simple and Inclusive: Various taxpayers can avail of the advantage of investing in 54EC bonds including individuals, HUFs, and companies, which makes it a versatile choice for varying financial needs.

Complementary Returns: Although the 54EC bonds interest rate is moderate, they add an element of stability to a diversified investment plan, balancing higher-risk ventures.

By incorporating 54EC bonds into your financial strategy, not only can you mitigate tax liabilities but also ensure a secure and consistent return on your capital. So, whether you are a corporate entity or an individual, these bonds provide a reliable pathway to achieve tax-efficient financial growth.

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