Capital Gain: The Dilemma of Paying Tax vs. Saving Tax
In the last week’s issue of The Tax Talk, we have discussed above Section 54EC which provides that any Long Term Capital Gain (LTCG) arising from sale of Land or Building will be exempt from tax if the amount is invested in the specified bonds issued by NHAI/REC within a period of 6 months. The bonds are fully secured and it is presently offering interest @ 5% p.a. It may be noted that if the person doesn’t want to claim an exemption, LTCG would be taxable in general @ 20% (Effective rate = 20.80% after Education & Health cess).
One of the common questions is whether it is worthwhile to invest in 54EC bonds for earning just 5% p.a. The question has become all the more relevant in view of the fact that the lock in period has been raised from 3 years to 5 years whereas the interest rate has been reduced to 5% from 5.75%. Businessmen having high cost borrowed funds also invest in 54EC bonds to save tax even if repayment of loan would have been a better option for such taxpayers. Let us try to explore the commercial angel before investing.
For the sake of understanding, let us consider that Mr. Smart who is in the highest tax bracket & has earned LTCG of Rs. 1 Lakh. The decision to invest or not to invest shall be based on the comparison of the following two figures:
(a) The value of the of fund after 5 years if amount is straightway invested in specified bonds to save tax of 20.80% (Option A) and
(b) The value of the of fund after 5 years if Tax @ 20.80% is paid up-front & the balance amount of 79.20% is invested elsewhere (Option B).
Option A
The biggest advantage with option A is that Mr. Smart will be able to retain the entire amount of LTCG as against option B wherein they would be left with 79.20%. The value of Rs. 1 Lakh of LTCG at the end of each year & after 5 years will be as under:
Particulars |
Interest |
Tax @ 31.20% |
Interest |
Year end |
|
|
|
after Tax |
Value |
|
|
|
|
|
|
|
1st Year |
5,000 |
1560 |
3440 |
103440 |
2nd Year |
5,172 |
1614 |
3558 |
106998 |
3rd Year |
5,350 |
1669 |
3681 |
110679 |
4th Year |
5,534 |
1727 |
3807 |
114486 |
5th Year |
5,724 |
1786 |
3938 |
118425 |
Total Funds |
26,780 |
8,355 |
18,425 |
118,425 |
It is presumed that interest received above is invested in other secured securities yielding the same rate of return. The value of Rs. 1 Lakh invested will be Rs. 1,18,425/- after 5 years.
Option B
Mr. Smart will be left with only 79.20% (i.e., Rs. 79,200/-) which can be invested in business, mutual funds or anywhere at the prevailing market rate. The return would vary from person to person and on the basis of the nature of investment. The value of the funds after 5 years has been calculated by considering different rates of returns ranging from 8% to 16%.
Expected Rate of Return |
8.00% |
10.00% |
12.00% |
12.25% |
13.00% |
14.00% |
16.00% |
Tax @ 31.20% |
2.50% |
3.12% |
3.74% |
3.82% |
4.06% |
4.37% |
4.99% |
Post Tax Return |
5.50% |
6.88% |
8.26% |
8.43% |
8.94% |
9.63% |
11.01% |
1st Year post tax Interest |
4,359 |
5,449 |
6,539 |
6,675 |
7,084 |
7,629 |
8,718 |
2nd Year post tax Interest |
4,599 |
5,824 |
7,079 |
7,238 |
7,717 |
8,363 |
9,678 |
3rd Year post tax Interest |
4,852 |
6,225 |
7,663 |
7,848 |
8,407 |
9,169 |
10,743 |
4th Year post tax Interest |
5,119 |
6,653 |
8,296 |
8,509 |
9,159 |
10,052 |
11,926 |
5th Year post tax Interest |
5,401 |
7,110 |
8,981 |
9,226 |
9,979 |
11,020 |
13,239 |
Total Return in 5 years |
24,331 |
31,261 |
38,557 |
39,495 |
42,346 |
46,233 |
54,305 |
Value after 5 years |
103,531 |
110,461 |
117,757 |
118,695 |
121,546 |
125,433 |
133,505 |
