Restrictions on using capital gains bonds to save tax

Gains from asset classes apart from property have to be invested in other instruments

Capital gains bonds have been the best option to save tax if an individual profited from selling assets such as gold, bonds, house and unlisted stocks, after holding them for over three years. But, from April 1 onwards, taxpayers can only invest in the bonds if they have capital gains from property.

The Budget has proposed to restrict capital gains bonds only to property and also increased the tenure of such bonds from three to five years. Taxpayers now have very limited option to save long-term capital gains from assets other than property.

An alternative is to invest the gains in a residential house and take the benefit available under Section 54F of the Income-Tax Act. “If an individual invests gains from a long-term capital asset — other than property — he can save tax if he buys a residential unit using the funds,” said Naveen Wadhwa, general manager, Taxmann.com. But in this case, the entire funds — principal and profit — need to be invested in the house. In capital gains bonds, the taxpayer had the option to invest only the taxable portion up to ~500 million.

In the Budget 2016, the finance minister had announced another option to save capital gains tax. He said the government would notify funds for start-ups and taxpayers investing in these funds will be able to save tax just like they do it in capital gains bonds. But tax experts said such funds have not been notified yet. These funds would be a more attractive avenue to save tax.

Financial planners said if you only consider returns, capital gains tax bonds were the best option. “They are backed by the government and the returns are guaranteed,” said Suresh Sadagopan, founder, Ladder7 Financial Advisories. “When a person invests in these bonds, he doesn’t need to pay any tax on gains he had made from selling the asset. Only the interest that he receives from the bonds are taxable,” At present, National Highways Authority of India and Rural Electrification Corporation offer 5.25 per cent interest rate on these bonds.

If a taxpayer has gains from long-term capital assets other than property and is unable to use Section 54F, then he has to pay the relevant tax. But, don’t lose heart. If one rightly invests the money in mutual funds with track records, a taxpayer can make returns that match with what he makes on using Section 54EC.

Say, if a person sells a longterm capital asset for ~12 million. His tax liability comes to ~4.3 million. If he invests the money in capital gains bonds, he makes ~5.16 million after tax.

Instead, if he invests 50:50 in equity and debt, he would make ~5.23 million net of taxes, assuming equity portion gives 12 per cent and debt gives 7 per cent. However, if the equity returns fall to 10 per cent, his net returns will be close to ~5 million.