LTCG Tax @ 12.50%: 54EC Bonds still a smart Investment?




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LTCG Tax @ 12.50%: 54EC Bonds still a smart Investment?

 

Taxpayers can save Long Term Capital Gain (LTCG) tax arising from the transfer of capital assets by making investment under section 54EC in the specified bonds issued by REC/PFC/IRFC. Investment has to be done within a period of 6 months & there is a ceiling of Rs. 50 Lakh for exemption u/s 54EC. Presently, the bonds are offering interest @ 5.25% p.a., payable at annual rest & the same is taxable.

In respect of immoveable properties acquired prior to July 23rd, 2024, individual & HUF have a choice to pay tax at lower of (a) tax computed @ 20% under the old scheme with indexation benefit or (b) tax computed @ 12.50% under the new scheme without indexation benefit. If the tax calculated @ 12.50% is higher than taxpayers may continue to offer the tax @20% by availing the indexation benefit. Undeniably, the LTCG Tax rate which was 20% earlier has been reduced by the Finance Act (No. 2) of 2004 to 12.50%, albeit without the benefit of indexation.

Regardless of the option of 20% or 12.50%, taxpayers have a choice of saving tax by investing in 54EC Bonds. However, with the reduced 12.50% rate (effectively 13% after adding education cess @4%), the key question emerges:
a) Is it still worthwhile to invest in 54EC bonds, or are there better alternatives?
b) What could be the break even rate if taxpayers wish to invest the amount elsewhere rather than in 54EC Bonds?


Assessing the Alternatives: Bonds vs. Other Investments

To answer, we need the spreadsheet to know the value of the of fund after 5 years under following two options:
Option A: Amount is straightway invested in specified bonds to save tax of 13% and
Option B: Tax is paid first @ 13% & thereafter balance of 87% is invested elsewhere.

For a practical comparison, consider Mr. Smart, a taxpayer in the 30% income tax bracket (effective Tax Rate – 31.20% after adding 4% of education cess). He earns ₹1 lakh in LTCG and is evaluating whether (a) to invest in 54EC bonds or (b) pay the tax and invest the remainder in an alternate investment option. For the sake of simplicity & completeness, it is presumed that annual interest income from above investment of Rs. 1 Lakh will also yield the same return as original investment.

Option A- Investing in 54EC Bonds:
By investing ₹1 lakh in 54EC bonds, Mr. Smart avoids paying ₹13,000 in LTCG tax. Over five years, Mr. Smart’s returns, after accounting for tax on the interest income, would look like this:

 

Particulars Interest Tax @31.20% Interest After Tax Year end Value
1st Year 5,250 1638 3612 103612
2nd Year 5,440 1697 3742 107354
3rd Year 5,636 1758 3878 111232
4th Year 5,840 1822 4018 115250
5th Year 6,051 1888 4163 119413
     Total Funds 28,216 8,803 19,413 119,413

After five years, Mr. Smart’s investment would grow to ₹ 1,19,413 if he decide not to pay the tax and invest the amount in 54EC bonds @ 5.25%.

 

Option B- Paying LTCG Tax and Investing balance amount elsewhere:

If Mr. Smart opts to pay the LTCG tax of ₹13,000, he is left with ₹ 87,000 to invest. Let’s consider the outcome if he invests this elsewhere & gets returns in the range of 8% to 12%. After deducting taxes on the returns, the fund’s value after five years would be:

Expected Rate of Return 8.00% 9.439% 10.00% 12.00%
Tax @ 31.20% 2.50% 2.94% 3.12% 3.74%
Post Tax Return 5.50% 6.49% 6.88% 8.26%
1st Year post tax Interest 4,788 5,650 5,986 7,183
2nd Year post tax Interest 5,052 6,039 6,397 7,776
3rd Year post tax Interest 5,330 6,454 6,838 8,418
4th Year post tax Interest 5,623 6,898 7,308 9,113
5th Year post tax Interest 5,933 7,373 7,811 9,865
Total Return in 5 years 26,727 32,413 34,339 42,354
Value after 5 years 113,727 119,413 121,339 129,354

The value of LTCG of Rs. 87,000, would be Rs. 1,13,727, Rs. 1,19,413, Rs. 1,21,339 & Rs. 1,29,354 if the investment is yielding return @8%, 9.44%, 10% & 12% respectively. As we see, if Mr. Smart’s alternative investment yields a return of 9.44% or higher, he would be better off paying the tax and investing the remaining funds elsewhere, rather than opting for the 54EC bonds.

Of course, the above example is for taxpayers who are into the 30% tax bracket. For taxpayers who are in the 20% tax bracket, the above spreadsheet will depict the value of Rs. 1 Lakh after 5 years at Rs. 1,22,592 under option A and a person with return above 8.82% can opt for paying tax.

Conclusion:

Taxpayers must carefully evaluate whether saving LTCG tax through 54EC bonds is the optimal choice, especially in light of the reduced 12.50% LTCG tax rate. While 54EC bonds are a secure and fixed-return option, they may not be the most profitable route if other investments can offer higher returns. For those in the 30% tax bracket, the break-even point is a post-tax return of 9.44%. For taxpayers in the 20% tax bracket, paying LTCG tax and investing elsewhere becomes more attractive if the alternative investment provides returns above 8.82%.

While 54EC bonds provide a safe, tax-saving option, taxpayers must consider their personal financial goals and the potential returns of alternative investments. In some cases, paying the LTCG tax and exploring higher-return avenues may yield better overall financial outcomes. Taxpayers should make informed decisions based on their own financial circumstances.

 

The copy of the Attachments is as under:

Chart - 1 (3)

Chart - 2 (2)




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