Parking wealth in capital gains bonds a safe bet
The real estate transactions in India have traditionally been in cash at most point of time.
The real estate transactions in India have traditionally been in cash at most point of time. The demonetisation in 2016 has changed the way many transacted real estate properties and continued to do so.
It's not that there has been no account to account transfer (popularly known as white money) but the preference was in cash for transactions.
The government on its side has long provided for the mechanism on calculating the capital gains while also provision for saving these gains, albeit, restricted.
The capital gains i.e. profit from selling a land or building either residential or commercial, would attract tax. These capital gains are classified as Short-term and Long-term.
The classification is based on the tenure of holding of the property since purchased by the individual. If the property is held for over three years from date of purchase, then any gains from the sale proceeds attract Long-Term Capital Gains (LTCG) and the rest are considered as Short-Term Capital Gains.
The government, however, doesn't appropriate any concession or exemption on the Short-Term Capital Gains (STCG) i.e. less than three years from the date of purchase and are taxed at the individual tax slabs.
The Long-Term Capital Gains (LTCG) is taxed at 20 per cent of the gains with indexation and 10 per cent without indexation.
The tax provisions also provide for exemption of the LTCG through investing in Capital Gains Bonds, also known as 54EC bonds.
Section 54EC states that if the profit made on sale of a long-term capital asset from an immovable property when invested by the taxpayer in 'long-term specified assets' within six months of the sale, then the capital gains are exempt from taxation.
The minimum investment is one bond amounting to Rs 10,000 while a maximum of 500 bonds could be allowed amounting to Rs 50 lakh.
The gains from the sale proceeds could be parked in these bonds by an individual up to Rs 50 lakh. The current interest rate of these bonds stands at 5.75 per cent payable annually are nevertheless, taxed.
Though the effective post tax returns work out to be about four per cent to five per cent (depending upon the 10 per cent to 30 per cent tax slab), one may not completely ignore this option altogether to not just to save tax but also to preserve wealth.
This is because if one were to plan to invest the gains in higher performing investments, the immediate outgo would be at 20 per cent as tax on the LTCG.
For instance, for the Rs 100 gains made, the LTCG stands at Rs 20. The residual of Rs 80 would be explored to be invested in any of the higher yielding investments.
Instead, if an individual chooses to invest in 54EC bonds, the entire amount (though the limit is Rs 50 lakh) gets invested which earns a 5.75 per cent per year annually.
The principal is repaid after the end of five years with a positive cashflows of the interest every year during same time.
The Internal Rate of Return (IRR) for the highest tax bracket individual (i.e. at 30 per cent tax slab) works out to be upwards of 9.15 per cent and it turns out to be attractive at 10.32 per cent for the lowest tax slab (at 10 per cent).
This comes with a backdrop of guaranteed nature (AAA rated) and are considered to be safe for the quasi-government nature of the organisations, backed by the government.
The eligible bonds under section 54EC are REC (Rural Electrification Corporation Ltd), PFC (Power Finance Corporation Ltd), IRFC (Indian Railways Finance Corporation Ltd) and NHAI (National Highways Authority of India).
These bonds could be held either in physical or demat form as per the investor's preference. The tenure of each bond is for five years (effective from April 2018, prior it was for only three years) and are non-transferrable.
(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at email@example.com)