Tax Savings That Do not Actually Help Save Much
ever, it so happens that even a cursory examination reveals these bonds to be a most useless investment. Basically, if you have capital gains from the sale of an asset, you can avoid paying capital gains on it by investing up to .₹ 50 lakh in these bonds that are issued by NHAI and REC. The bonds are for three years and earn a mere 6% interest, which is itself taxable. Since most investors are in the top tax bracket, they effectively earn 4% from these bonds, which, over three years, is a post-tax opportunity loss of at least 10% compounded, even when compared to a debt fund.
It so happens that if you had paid capital gains tax on the original gains, after allowing for cost inflation, you would either gain a bit, or at the very least, break even with these capital gains bonds. You would have the money available for deploying in other more useful ac- tivities right away, instead of being locked for three years. Many people who are in this situation understand this and yet buy capital gains bonds. Why? Because it saves tax. This behaviour, as well as various observations during the demonetisation period, has made me come to the conclusion that rich Indians have a pathological hatred of paying taxes, even if it makes no financial sense.
Looking at the above example, it’s crystal clear that the capital gains bonds are effectively not tax-free. By paying you a pittance as interest (and then taxing that interest as income), the government is actually taxing you fully, specially when you consider that the bond issuing entities would otherwise have to be funded by the government.
Capital gains bonds are a bad investment. However, people who are otherwise financially smart keep falling for it just because they have a ‘tax saving’ label on them.