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The bond of gains

Nitya Varadarajan     October 2, 2008
Should you invest in capital gains bonds after, say, you have sold property? Most investors would be inclined to do so, considering that it helps save a bundle in capital gains tax. But among the many things you must consider before investing is what your eventual pay-off will be, and how far away you are from retirement.

Investors have to buy capital gains bonds within a period of six months from the date of booking capital gains. Under Sec. 54EC of the Income Tax Act, investors get an exemption from long-term capital gains tax on their investments. The investment, however, comes with a lock-in period of three years, but the interest rate is a lowly 5.75 per cent. The consolation for many risk-averse investors, however, is that the bonds carry a high rating and sovereign guarantees, which is considered very safe.

In the market as of now, the interest rates on other fixed income products are hovering around the 10 per cent mark. That is considerably higher than the 5.75 per cent interest rates on the capital gains bonds. Experts, however, reckon that since the rates are low, only those investors who are seeking a very high degree of safety should go for these bonds—these are especially suitable for retirees. Says Y.S. Suresh, Financial Advisor, Bajaj Capital: “Capital gains bonds are ideal for people nearing retirement or those who are extremely conservative in their outlook. But for those in the younger age group, there’s an option of investing in an equity mutual fund with a dividend option.” Suresh goes on to suggest that with the dividend payout, one can still pay the capital gains tax, and be left with a net gain that can be better than the 5.75 per cent returns from the capital gains bonds.

Bonds on the street
Capital gains bonds can help save a bundle in taxes

Another issue that investors must consider about capital gains bonds is that the interest returns are taxable. So, if you are in the highest tax bracket of 30 per cent, you will have to pay Rs 1,725 as taxes on the interest of Rs 5,750 on 10 bonds with face values of Rs 10,000 each. This reduces the yield in the hands of investors. In real terms, the posttax yield per annum works out to around 4.02 per cent on your original investment. “There is no free lunch,” says Pradeep Yuvaraj, Director, Finerva Financial Services, a wealth management company.

Another option, particularly for conservative investors, is to buy another property to reduce the tax burden. Investors can buy another property within three years. Meanwhile, the surplus money can be deposited in a Capital Gains Scheme of Deposit Account with a public sector bank till such time that you use the money to purchase a property. So, considering the many situations, choose your option that suits you best. If safety and a regular income are what you require, capital gains bond is your answer.

The pros
• The bonds are offered on tap, but scheme closes after it mobilises full subscription
• It frees up the saved capital gains tax for other investments, such as equities
• The bonds are safe and have a high credit rating; interest payments are made annually

The cons
• The rate of interest on capital gains bonds is low, and is also taxable
• The bonds have a long lock-in period of three years, so it's not liquid to that extent
• The post-tax yield on these bonds is very low; investors can get better returns elsewhere

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