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54EC Bonds: Capital Gain Bonds Features & Benefits with Examples

Whether you refer to them as Capital Gains Bonds or 54EC Bonds, these investment instruments offer an incredible opportunity to safeguard your long-term gains. These Bonds are exclusively for investors who wish to get tax exemption on their long-term capital gains. These Bonds are a highly popular investment instrument, providing investors with tax-saving opportunities. 

What section 54EC of the Income Tax Act of 1961 says? 

Section 54EC of the Income Tax Act of 1961 states that those gains will not be subject to taxation if taxpayers invest their capital gains in certain 54EC Bonds within six months of selling a long-term capital asset like property or stocks. These bonds are issued by government-backed infrastructure companies, which makes them relatively low-risk. The 54EC bonds are highly rated by credit rating agencies such as CRISIL, ICRA, and CARE, receiving AAA ratings. 

What are the Features of 54EC Bonds? 

  1. Eligible Assets – 54EC Bonds are specifically designed for the investment of capital gains from the sale of long-term assets like land, building, house, jewellery, shares etc. And if any investor wishes not to pay tax on their capital gains, then he/she can invest in these Bonds.  
  1. Lock-in Period – The invested amount in the 54EC Bond is locked for 5 years (which earlier was 3 years). During the tenure, the Bonds cannot be redeemed or transferred. So, it’s better for the investor to consider the lock–in period before investing in the 54EC Bonds. 
  1. Coupon Rate – 54EC Bonds provide a fixed interest rate throughout the Bond’s tenure. Currently, the interest rate offered on 54EC Bonds to the investor is 5% on an annual basis which is determined by the Government of India.  
  1. Investment Amount – The minimum investment amount for 54EC Bonds is Rs 10,000 for 1 Bond, and the maximum amount that can be invested is Rs. 50 Lakhs/- per assessee.  
  1. Credit Rating – The credit rating assigned in the 54EC Bonds is given by renowned credit ratings agencies such as ICRA, CRISIL and CARE. And these Bonds generally get a rating of AAA, which indicates a high level of creditworthiness and stability. 
  1. Demat Account – 54EC Bonds can be held in the Demat Accounts or in the physical form based on the preference of the investor.  

What are the Benefits of 54EC Bonds? 

  1. Diversification – Investing in 54EC Bonds provides an opportunity for diversification to the investor. Instead of reinvesting the capital gains in the same asset class, the investors can allocate those funds and invest in Bonds, which are issued by Government-backed infrastructure companies.  
  1. Low Risk – 54EC Bonds are typically issued by government-backed infrastructure companies, ensuring a certain level of security. These bonds are considered relatively low-risk investments due to the backing of credible institutions and their higher credit ratings assigned by credit rating agencies. 
  1. Regular Income – The bonds offer a fixed rate of interest, providing investors with regular income in the form of interest payments. This can be beneficial for individuals seeking a steady income stream during the bond’s tenure. 
  1. Liquidity – While 54EC Bonds have a lock-in period of three years, they still offer a certain level of liquidity. Investors have the option to sell these bonds in the secondary market before maturity if they wish to exit the investment early. However, it’s important to note that the availability of buyers and prevailing market conditions can affect the liquidity of the bonds. 
  1. AAA Credit Rating – 54EC Bonds are typically assigned AAA credit ratings by renowned credit rating agencies. This indicates a high level of creditworthiness and stability, providing investors with confidence in the bond’s reliability. 

Why do investors prefer Capital Gain Bonds? 

Capital Gain Bonds are considered to be the right place to park funds for investors who do not want to invest in another property/capital asset. It helps them save long-term capital gain tax, which would attract 20.8% tax (20% + 4% health and education cess) in the case of property, jewellery, etc., with indexation and 10.4% (10% + 4% health and education cess) tax if listed securities and equity-oriented mutual funds (above Rs.100,000). There is no slab rates taxation for long-term capital gains like in the case of short-term capital gains. So irrespective of the investor’s income level, the LTCG tax rate will be fixed. (As the FY2023 budget, debt-oriented MFs, will no longer enjoy LTCG benefits and indexation, they will be charged as per slab rates of the investor, like short-term capital assets). 

Type of Asset Long-Term Capital Gains Rate 
Listed Securities and Equity oriented MFs  10% + cess + surcharge 
Real estate, Jewellery, unlisted securities, Debt oriented MFs etc. 20% + 4% cess + surcharge 

With a taxable return of 5% in the 54EC capital bonds, is there a better channel for the taxpayer to moderate his funds arising from the sale of capital assets? If he doesn’t intend to buy or construct another immovable property, he will have to pay tax on his LTCG. But what if he decides to pay the tax and re-invest his remaining proceeds in higher return security? Let’s try to project cashflows in multiple situations to understand what is the optimal choice for an investor. 

Example A: Mr A has sold his immovable property and earned an LTCG of Rs.50,00,000/-. He doesn’t wish to re-invest his proceeds in another asset. His choices would be: 

a) To buy 54EC bonds for Rs.50,00,000/- and earn 5% interest p.a. for 5 years 

b) Pay tax @20.8% (assuming no surcharge) and reinvest balance Rs. 39,60,000 in fixed income security with 8%-12% return. We have assumed that the investor reinvests the interest at the same rate.  

Cashflows after 5 years if:  10% tax bracket 20% tax bracket 30% tax bracket 
54EC Bonds @5% ₹ 62,43,267 ₹ 61,05,126 ₹ 59,66,985 
Invests @ 8% ₹ 56,32,685 ₹ 54,46,831 ₹ 52,60,977 
Invests @ 10% ₹ 61,35,858 ₹ 58,94,096 ₹ 56,52,334 
Invests @ 11% ₹ 64,01,547 ₹ 61,30,264 ₹ 58,58,981 
Invests @ 12% ₹ 66,76,986 ₹ 63,75,098 ₹ 60,73,211 
Click here for detailed Cashflows 

As per the above calculations, it is clear that an investor will maximise his returns if he invests in 54EC capital gain bonds instead of paying LTCG and investing in 8-10% interest-bearing securities. But if he can choose to park his balance funds post-taxation into 11/12% return-bearing fixed-income securities, he will beat the cashflows earned from 54EC bonds. To invest in a bond with an 11-12% return, the investor will have to choose lower-rated papers like A+, A, BBB, etc. If an investor has a larger risk appetite and can opt for higher yield, lower-rated bonds, he will earn a much higher return than their secured counterparts. 

Example B: Mr B has sold his listed securities and earned a LTCG of Rs.50,00,000/-. He doesn’t wish to re-invest his proceeds in another property. His choices are: 

a) To buy 54EC bonds for Rs.50,00,000/- and earn 5% interest p.a. for 5 years 

b) Pay tax @10.4% (assuming no surcharge) and reinvest balance Rs. 44,80,000 in fixed income security with 8%-12% return. We have assumed that the investor reinvests the interest at the same rate 

Cashflows after 5 years if: 10% tax bracket 20% tax bracket 30% tax bracket 
54EC Bonds @5% ₹ 62,43,267 ₹ 61,05,126 ₹ 59,66,985 
Invests @ 8% ₹ 63,72,331 ₹ 61,62,072 ₹ 59,51,813 
Invests @ 10% ₹ 69,41,576 ₹ 66,68,068 ₹ 63,94,559 
Invests @ 11% ₹ 72,42,154 ₹ 69,35,248 ₹ 66,28,342 
Invests @ 12% ₹ 70,33,762 ₹ 66,92,233 ₹ 63,50,704 
Click here for detailed Cashflows 

The above table shows how an assessee is better off paying taxes @ 10.4% (assuming no surcharge) than investing in 54EC bonds. The assessee in a 30% or above has a marginal difference which can be covered by choosing a bond giving a slightly higher return than 8%.  

54EC Bonds are an excellent option to save tax, however, giving leeway to investors who can stomach a higher risk and choose to go via the tax route. Also, investors who are liable to a 10.4% rate of LTCG clearly can give these bonds a miss as they can earn better cashflows via g-secs, AAA-rated bonds, giving a yield of 8% and more.  

What are the Eligibility and Investment Criteria? 

  1. Investor – Only individuals and Hindu Undivided Families (HUFs) are eligible to invest in them and avail of the benefits. Non-resident Indians (NRIs) and other entities, such as partnerships and corporations, are permitted to invest in these bonds but will not be granted the tax exemption under section 54EC.  
  1. Investment Timeframe – The investor needs to make an investment in 54EC Bonds within 6 months from the date of the sale of their asset, which tends to generate capital gains. If the investment is not taking place within this timeframe, then the investor will not get any tax benefit provided by the Bonds. 
  1. Investment Mode – Investment in 54EC Bonds can be made in any way by the investor, either in demat or in physical form.  
  1. Source of Funds – If you want to invest in 54EC Bonds, the amount you seek to invest must originate from the long-term capital gains obtained through the sale of assets like buildings, property or shares. 

Who issues Capital Gains Bonds? 

The bonds that are eligible for capital gains exemption, commonly known as 54EC bonds, are issued by specific financial institutions such as REC (Rural Electrification Corporation Ltd), IRFC (Indian Railways Finance Corporation Limited) and PFC (Power Finance Corporation Limited). It’s worth noting that previously, NHAI (National Highways Authority of India) used to issue these bonds; however, they have discontinued issuing them starting from the fiscal year 2022-23. Therefore, currently, investors can invest in 54EC bonds issued by REC, PFC, and IRFC to avail of the capital gains tax exemption benefit. 

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Bottom Line 

In conclusion, 54EC Bonds, also commonly called Capital Gains Bonds, provide a compelling investment option for investors who wish to diversify their investment portfolio and save their tax on long-term capital gains. 54EC Bonds provide value-added benefits like regular income, security, and low-risk avenues in the investment sphere. But before making any investment decision, it is highly advisable to consult an advisor who ensures that you make informed investment decisions.