54 EC Bonds

Taxes can drain out an investor’s annual earnings. Tax Planning is a legitimate tool to reduce tax liabilities while conforming to the legal obligations and hence, tax planning comes as an effective tool in financial planning.

54EC bonds, or capital gains bonds, are one of the best ways to save long-term capital gain tax. 54EC bonds are specifically meant for investors earning long-term capital gains and would like tax exemption on these gains.

The nomenclature of the financial instrument i.e., 54 EC accrues to the fact that these bonds are those assets which enables long term capital gains exemption under Sec54 EC of the Income Tax Act,1961. So, in order to understand what this financial instrument is all about, its crucial to know more about the Sec 54 EC.

What is Sec 54EC of the Income Tax Act,1961?

Where the capital gain arises from the transfer of a long-term capital asset and the assessee has, at any time within a period of six months after the date of such transfer, invested the whole or any part of capital gains in the long-term specified asset, the capital gain shall be dealt with in accordance with the following provisions of this section —

(a) if the cost of the long-term specified asset is not less than the capital gain arising from the transfer of the original asset, the whole of such capital gain shall not be charged under Section 45;

(b) if the cost of the long-term specified asset is less than the capital gain arising from the transfer of the original asset, the cost of acquisition of the long-term specified asset shall not be charged under Section 45.

Provided that the investment made on or after the 1st day of April 2007 in the long-term specified asset by an assessee during any financial year does not exceed fifty lakh rupees.

An example to illustrate.

Point (a)-

Point (b)-

This Section poses a plethora of questions and doubts in the minds of the investor. Some of the FAQs are:
Q) What is a long-term capital asset and on which long term capital asset, capital gain is eligible for deduction u/Sec 54EC?
A) The Finance Act 2017 provides that in case of an immovable property being land or building or both, the period of holding should be 24 months or more to qualify as long-term capital asset. The deduction u/s 54EC is restricted to only transfer or sale of Land or building or both by Finance Act 2018.

Q) Who all are eligible for deduction u/Sec 54EC?
A) Any assessee can claim exemption u/Sec 54EC. Therefore, an Individual, HUF, Company, LLP, Firm etc can claim this exemption.

Q) What is a long-term specified asset?
A) “Long-term specified asset” for making any investment u/s 54EC means any bond redeemable after five years and issued by National Highways Authority of India (NHAI) or by Rural Electrification Corporation Limited or any other bond notified by central government.
Finance Act 2018 has extended the time period to 5 years earlier it was 3 years only.

Q) What is Sec45 of Income Tax Act, 1961?
A) Section 45 of Income Tax Act, 1961 provides that any profits or gains arising from the transfer of a capital asset effected in the previous year will be chargeable to income-tax under the head ‘Capital Gains’. Such capital gains will be deemed to be the income of the previous year in which the transfer took place.

Q) Can Short Term Capital Gains be eligible for Exemption u/Sec 54 EC?
A) No, only long-term capital gains that too on transfer/sale of land or building are eligible for deduction u/Sec54 EC.

Q) What are the time specifications to avail the exemption?
A) The investment of capital gains in these bonds should be made within the period of 6 months from the sale of the long-term asset (from which capital gains are realized).

Q) What is the maximum limit of capital gains exemption u/Sec 54 EC?
A) Investment made by an assessee during the financial year in which the asset or assets are transferred and in the subsequent financial year does not exceed Rs 50 Lakh. Hence, maximum limit of capital gains exemption u/Sec 54 EC is Rs 50 Lakh.

To illustrate this point:

In this case, Capital Gains were invested within 6 months of sale and within 2 different financial years. Ideally, the investor could avail capital gains deduction u/Sec54 EC of Rs 1 crore. But this loophole was taken care of by the Second Proviso u/s 54EC which states Investment made by an assessee during the financial year in which the asset or assets are transferred and in the subsequent financial year does not exceed Rs 50 Lakh. Hence, following will be the treatment in the above situation.

Q) Can the assessee transfer the 54EC Bonds before the redemption period of 5 years?
A) Finance Act 2018 provides that if the assessee transfers 54EC Bonds or takes any loan or advance on the security of such bonds within the period of 5 years from the date of acquisition of the bonds, the capital gains arising from the transfer which were earlier not charged u/s 45 on basis of the cost of “long-term specified asset i.e. 54 EC Bonds” shall be deemed to be the income chargeable under the head “Capital Gains” of the Previous year in which the 54 EC Bond is transferred or converted into money.

Now that we have understood all about Sec 54EC of the Income Tax Act, 1961; let us dive into some features 54 EC Bonds.

Eligible Bonds– The eligible bonds under Section 54EC are REC (Rural Electrification Corporation Ltd), PFC (Power Finance Corporation Ltd) and NHAI (National Highways Authority of India) and IRFC (Indian Railways Finance Corporation Limited) or any other bond notified by central government.

Returns– The 54EC bonds offer an annual interest rate of 5-5.75 percent.

Risks– These Bonds are AAA Rated. The default rate is extremely low.

Time Horizon– These are 5-year Bonds.

Taxes– Interest is taxable at applicable rates under the head “Income from other sources”. No tax is deducted at source (TDS) on interest from 54EC Bonds and wealth tax is exempted.

Liquidity– The lock-in-period is 5 years and hence, are irredeemable and are non-transferrable.

Unique Feature– It enables long term capital gain exemption u/Sec54 EC.

Limits– The maximum limit for investing in 54EC bonds is ₹50 lakh per financial year, whereas minimum investment is capped at ₹20,000 and ₹10,000 respectively in REC and NHAI bonds.