capital gain bond
Financial instruments can be divided into two types – market-linked financial instruments and fixed-income financial instruments. Market-linked financial instruments consist of equity shares, equity-oriented Mutual Funds, etc. Fixed-income instruments include government bonds, debentures, fixed deposits, etc.
Bonds are one such fixed-income financial instrument which can also be considered as interest-bearing debenture certificates. Government bonds largely constitute the bond market in India. These bonds are open to the financial market as well individuals dealing in the stock market.
Any financial instrument offers excellent financial leverage to an investor as their existing capital can be used to generate returns for them instead of remaining unused. Investments in bonds can also be done to save on long-term capital gains tax. Such bonds are called 54EC bonds or Capital Gain Bonds.
Different Kinds of Bonds
1. Government bonds
These bonds are directly issued by the Central Government. They are also called Sovereign Bonds. As these bonds are issued by the Union, they incur low risk for the investor. However, the rates of return on these investments are low. For example, recently a 7.75% GOI Savings Bond was introduced in January 2018 which replaced the previous 8% Savings Bond. An individual with a low-risk appetite can opt for government bonds.
2. Municipal Bonds
Municipal bonds are issued by State governments and municipal corporations. These bonds also provide assured returns, albeit against a comparatively lower interest rate when compared to high-risk bonds.
3. Public sector bonds:
These bonds are issued by companies or corporations whose 50% shares or more are owned by the Central government. These bonds also have a low-risk factor as these are guaranteed by the Government of India.
4. Corporate bonds:
This kind of bonds is also popular in the stock market; however, it does not cover as much ground as government bonds. That is because these bonds entail high risk because these are issued by private corporations or companies. However, they offer higher returns compared to government bonds and an individual with a high-risk appetite can avail these investment avenues.
How is Investment in Capital Gains Bonds Better than Other Investments?
This factor depends on the rate of return as well the maturity period on other investments.
An example would better explain the difference between 54EC bonds and other investment options and whether it is profitable for an investor to gain more from other investments even if they need to incur taxes on those.
Suppose Ms Y invests Rs. 50,00,000 in bonds from NHAI or REC for 5 years with a capital gains bonds interest rate of 5.25% and Ms Z invests the same amount in a different form of investment option for a similar period where the rate of return is 10%.
Now, as the capital gain of Rs. 50,00,000 is exempt from tax, the post-tax amount for it will remain unchanged. In the case of Ms Z, payable tax amount is Rs. 13,12,500 bringing down her taxable income to Rs. 36,87,500.
As Y would receive 5.25% on Rs. 50,00,000, her total income from that bond on maturity would be Rs. 63,12,500. Z’s earning, on the other hand, would be calculated on 10% which would make her total income on maturity Rs. 55,31,250. It can be seen that the amount in case of Ms. Z is less than that of Ms. Y. Therefore, the rate of return and the maturity tenure play a pivotal role in deciding which investment avenue to opt for when reinvesting capital gains.