Reducing Your Tax Liabilities with 54EC Bonds
Why You Need to Know the Rules of the Game
Taxes are a part of investments, which you cannot escape. As you gain returns on your investment, tax liability knocks on your door. For investments, it is typically capital gains on which you are required to pay taxes.
Capital gains are profits made by you when you sell your investments. It is classified into two parts: Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG). Both these gains have different tax rates based on different time frames as per asset classes
For example, for listed bonds, STCG is applicable as per your tax slab if you sell your bonds within 12 months. On the contrary, for unlisted bonds, the same duration is 36 months. If you sell your investments after these periods, they attract long-term capital gains. The LTCG on listed and unlisted bonds is 10% and 20%, respectively, without the benefit of indexation unless you have invested in government-issued Capital Indexed Bonds or Sovereign Gold Bonds.
In this article, we will take a look at the applicable tax implications on different government and corporate bond categories.
Tax implications on government bonds
There are three popular bonds categorized under government-issued bonds as below.
Government Securities (G-sec) Bonds
G-Sec bonds are debt instruments issued by the government. The interest you earn on this bond is treated as per your tax slab. The STCG and LTCG timeline works the same as we described above. LTCG on listed G-sec is charged at 10% and for unlisted at 20% (with indexation benefits). STCG is again charged as per the applicable tax slab.
Sovereign Gold Bonds (SGBs)
These bonds are issued by the RBI, and the denomination is in grams. SGBs provide you tax exemption and return on your investments along with the value appreciation of gold.
By investing in SGB, you not only get the benefit of investing in gold but also earn a 2.5% return. If you sell your physical gold, you pay 1% TDS, but for SGB, it is 0. Also, the return you receive on investing in this bond is tax-free if you stay invested for the entire 8 years of maturity.
SGBs have a lock-in period of 5 years. If you sell the bond after 5 years, 20% LTCG tax is applicable with cess minus indexation benefits. While if you sell the bonds before 3 years in the secondary market, STCG tax will be applicable as per your tax slab. There is no tax if you hold the bonds for 8 years, which is the maturity term.
Zero coupon bonds
Zero coupon bonds are issued by both government entities and corporations, too. These bonds do not pay you any interest but are issued at a huge discount. So, you invest in these bonds for a lower value and, at maturity, get paid the face value. As there is no interest income, there is no associated tax. However, the capital gain is taxable. For a 12 period, STCG is based on your tax slab. For LTCG, your tax liability is 10%.
Tax implications on corporate bonds
In the case of corporate bonds, you will earn a higher return due to the risk involved. The tax liability on the return you gain on these bonds is the same as a G-sec bond. For the capital gains, any gains over 12 months for listed bonds and 36 months for unlisted bonds are charged at 10% and 20%, respectively, as LTCG tax. STCG, on the other hand, is as per your tax slab.
Zero-coupon bonds, as mentioned above, can also be issued by corporations or companies to raise funds for expansion or projects. The tax implications on these bonds remain the same as the government-issued zero-coupon bonds.
The bottom line
There is always a benefit when you hold bonds for the long term, as LTCG is taxed at lower tax rates compared to STCG, especially for listed bonds. Hence, even the government encourages investors to go for the long-term and let their money compound and minimize their taxes. You should invest in these bonds based on your goals and risk profile.
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