The Finance Act 2000 for the first time had provided 'Capital Gain Bonds' which are aimed at bringing zero-tax liability to the taxpayers deriving long-term capital gain on selling their various properties. The taxpayers are very well aware that in case of all categories of taxpayers deriving long-term capital gains on selling their properties there is a tax liability equal to 20% in respect of the entire amount of long-term capital gains.
On and from the Financial Year 2000-2001 relevant to the Assessment Year 2001-2002 the best way to save tax in respect of long-term capital gains arising on selling properties is as a result of certain investments as are contained in the section 54EC which had been introduced by the Finance Act, 2000.
As per this section 54EC all categories of tax payers whether the individuals, HUFS, partnership firms, corporate sector or other categories of tax entities would be able to save tax in respect of long term capital gains by making investments in certain Bonds which have been prescribed in this section 54EC.
For all those taxpayers who are interested to save their Income tax on the long-term capital gains the most important point to be borne in mind is that the entire long term capital gain arising on selling the immovable properties should be invested in these capital gains bonds. Another pertinent point is that the investment in these bonds should be made within 6 months after the date of transfer of the capital asset.
Hence, in case the investment is made in the bonds after a period of 6 months from the date of transfer of the real estate, then the investment in these bonds would not be eligible for tax exemption in respect of long-term capital gains arising on selling the immovable properties. Similarly, saving of capital gains consequent to investment in these new bonds is possible only in respect of long-term capital gains. Therefore, if a taxpayer were to make investment for saving tax on short-term capital gains, then the benefit of investment in terms of new section will not be available.
Section 54EC clearly mentions that the Bonds issued by National Bank for Agriculture and Rural Development (NABARD), National Highway Authority of India (NHAI), Rural Electrification Corporation Ltd. (REC), National Housing Bank (NHB), and Small Industries Development Bank of India (SIDBI) would be covered as eligible investment in terms of this section 54EC of the Income Tax Act, 1961. Investment in other mutual funds, or any other Bonds etc. will now not be eligible as approved investments so as to save tax in respect of long-term capital gains while selling your property.
Another salient feature of the above-mentioned bonds is that these bonds should not be sold at any time within the period of 3 years from the date of its acquisition. Hence, these Capital Gains Bonds should not be transferred or converted into money at any time within the period of 3 years from the date of investment in these bonds.
In case these Capital Gains Bonds are transferred or converted into money in less than 3 years time from the date of its acquisition, then the money so realised or the value of such bonds shall be deemed to be the income chargeable under the head capital gains in the previous year in which these bonds are transferred or converted into money. Hence, those tax payers who are Investing in these new Capital Gains Bonds should ensure that these bonds are neither sold nor even gifted within 3 years of its purchase, otherwise the objective of saving capital gains in respect of these bonds will not be achieved.
Another restriction which has been put by this section 54EC on the investor in the 'Capital Gains Bonds' is that the tax payer should not take any loan or advance on the security of these bonds.
In case any loan or advance is taken as a result of keeping these bonds as a security, then the amount of loan or advance so taken shall be deemed to have converted these bonds into monev on the date on which loan advance is taken and the same will therefore become liable to tax as a long term capital gain. In view of this important condition those who are contemplating to make investment in the Capital Gains Bonds must ensure that they do not take any loan or advance against these bonds.
One should also be very careful is not taking tax rebate in respect of these bonds u/s 88 of the Income Tax Act, 1961. Thus, it implies that if the investment has been made by the taxpayer in the above-mentioned capital bonds, such investment will be eligible only for the tax benefit u/s 54EC of the Income Tax Act, 1961 and the same will be admissible as investment for the purpose of tax rebate u/s 88 of the Income Tax Act, 1961.
The most important point which should be taken into account while making investment u/s 54EC so as to do away with payment of tax on long term capital gain is that the entire long-term capital gains should be invested in the bonds issued only by NABARD, NHAI, NHB, REC, or SIDBI. Hence, to take full advantage of the tax benefit one should in the first place calculate the quantum of long-term capital gain and thereafter make investments of such long-term capital gains so as to completely do away with tax payable in respect of long-term capital gains. Some times it may so happen that the assessee may be interested to invest only a part of the long term capital gains in the above mentioned bonds and part of the money he will like to keep with himself for some other use.
In such circumstances this section provides that if the investment in Capital Gains Bonds is less than the capital gains arising from the transfer of the original assets, then so much of the capital gains as bears to the whole of the capital gains the same proportion as the cost of acquisition of the capital gains bonds bears to the whole of the capital gains will be chargeable to tax u/s 45.
Thus, it is provided that in case the entire long term capital gains is not invested in these bonds and a portion alone is invested in the bonds, then the tax saving will be limited pro-rata to the amount of investment. For example, if the cost price of a property which has been sold is Rs 4 lakhs and the sale price is Rs 10 lakhs. The net long term capital gains is Rs 6 lakhs. Let us presume that investment has been made of Rs 4 lakhs in the bonds issued by National Bank for Agriculture and Rural Development.
Hence, in this illustration the assessee will be required to pay tax @ 20 % in respect of balance long-term capital gains amounting to Rs 2 lakhs. It may be noted here that the amount of long-term capital gains, which has to be invested in these Bonds, has to be arrived at after applying the concept of 'Cost Inflation Index'.
Whether to invest in these new Capital Gains Bonds or not to invest can be decided only after taking into account the money need of the assessee as also the net cash flow chart and finally the net yield on the investment available after making payment of long-term capital gains tax. These bonds would carry interest rate, which will be intimated by the organisation issuing them from time to time.
Generally, it is expected that the interest rate these days will be anything between 5% to 5.5% p.a. However, the interest rate arising from these bonds is eligible to tax deduction to the extent of only Rs 12,000 per annum u/s 80L of the Income Tax Act, 1961 for the Assessment year 2004-2005.
Finally it may be noted that the concept of saving tax in respect of long term capital gains would be applicable for capital gains arising on real estate investments as also on other investments.