“LTCG: PAYING TAX MAY BE BETTER THAN SAVING TAX”
“LTCG: PAYING TAX MAY BE BETTER THAN SAVING TAX”
CA. PAYAL MANISH RATHI
THE FACT:
- Long Term Capital Gain (LTCG) is blatantly taxable @ 20%.
- No deduction under Chapter VIA (like u/s 80C towards PPF/LIC/NSC etc) is available against the Long term capital gain.
TAX SAVING OPTIONS:
A tax payers having long term capital gain have the following two options:
- Pay Tax @ 20% or
- Save Tax by investing in Approved mode.
SAVING LTCG TAX U/S 54EC:
One of the most popular tax saving option for all spectrum of tax payers is to save tax by investing the LTCG in the bonds issued by the
- National Highway Authorities of India (NHAI) or
- Rural Electrification Corporation (REC).
This are very commonly referred to as the “54EC Bonds”.
The maximum amount that can be invested in such bonds is Rs. 50 Lacs p.a. Presently, Interest offered by NHAI/REC on this bond is around 6% p.a.
The fund has an opportunity cost. The fund, if not invested in the 54EC bonds, can be utilized elsewhere having higher return perspectives.
The questions remains: Is it worth Investing in the bonds considering such a lower rate of interest offered?
This is particularly more important in the current scenario where
a] Bank FDR offers returns in the range of 9% to 11% p.a.
b] Mutual Funds/ Equity investment offering returns in the range of 15% to 20% p.a.
c] Business or Gold/ Silver or Other Investment yielding more than 20% p.a.
Of the two options available with the tax payer, paying or saving, which is favorable? At what rate of return, paying tax is better than saving tax?
Let us analyze the case of Mr. X who has earned a Long term capital gain of Rs. 10 Lacs during the F.Y. 2010-11. For the sake of simplicity, it is presumed that other income of Mr. X is in 30% tax bracket (i.e., 30.90% with Education Cess).
1st OPTION:
SAVE TAX BY INVESTING IN THE 54EC BONDS:
1. The interest rate offered by the bonds is around 6% p.a.
2. After investment, the Long term capital gain tax liability would be Nil.
3. Mr. X have entire amount of Rs. 10 Lacs to invest in the Bonds.
4. The interest income from this bond is taxable.
5. The value of Rs. 10 Lacs invested on 31.03.2011 @ 6% p.a. would be as under:
Amount Invested Rs. 1000000
Interest offered 6.00% 6.00% 6.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 1000000 1041460 1084639
Interest Income [b] 60000 62488 65078 187566
Tax on Interest Income [c] 18540 19309 20109 57958
Interest ater Tax [d] = [b-c] 41460 43179 44969 129608
Value of the Fund at the Year End [e] = [a+d] 1041460 1084639 1129608 1129608
RESULT: The value of the fund at the end of 3 years would be Rs. 11.29 Lacs.
2nd OPTION:
PAY TAX @ 20% & INVEST THE AMOUNT ELSEWHERE:
If Mr. X pays tax @ 20.60% (including 3% of education cess). He would be required to pay tax of Rs. 2.06 Lacs & would be left with amount of Rs. 7.94 Lacs to invest elsewhere.
The various investments option could be of Investment in:
- Bank FDR with interest in the range of around 9% to 10% or
- Equity Market/ mutual fund or in the business where the yield could vary depending upon the market conditions or the business prospective. Businessmen normally prefer to invest the amount in the business where they may able to earn even more than 20% return on the capital.
Let us compare the value of Rs. 7.94 Lacs invested by Mr. X at different rate
A] If the return is @ 9% p.a.:
Amount Invested Rs. 794000
Interest offered 9.00% 9.00% 9.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 843379 895829
Interest Income [b] 71460 75904 80625 227989
Tax on Interest Income [c] 22081 23454 24913 70448
Interest ater Tax [d] = [b-c] 49379 52450 55712 157541
Value of the Fund at the Year End [e] = [a+d] 843379 895829 951541 951541
RESULT: The value of the fund at the end of 3 years would be Rs. 9.51 Lacs.
B] If the return is @ 12% p.a.:
Amount Invested Rs. 794000.00
Interest offered 12.00% 12.00% 12.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 859838 931136
Interest Income [b] 95280 103181 111736 310197
Tax on Interest Income [c] 29442 31883 34526 95851
Interest ater Tax [d] = [b-c] 65838 71298 77210 214346
Value of the Fund at the Year End [e] = [a+d] 859838 931136 1008346 1008346
RESULT: The value of the fund at the end of 3 years would be Rs. 10.08 Lacs.
C] If the return is @ 15% p.a:
Amount Invested Rs. 794000.00
Interest offered 15.00% 15.00% 15.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 876298 967126
Interest Income [b] 119100 131445 145069 395614
Tax on Interest Income [c] 36802 40617 44826 122245
Interest ater Tax [d] = [b-c] 82298 90828 100243 273369
Value of the Fund at the Year End [e] = [a+d] 876298 967126 1067369 1067369
RESULT: The value of the fund at the end of 3 years would be Rs. 10.06 Lacs.
D] If the return is @ 18% p.a:
Amount Invested Rs. 794000.00
Interest offered 18.00% 18.00% 18.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 892758 1003799
Interest Income [b] 142920 160696 180684 484300
Tax on Interest Income [c] 44162 49655 55831 149648
Interest ater Tax [d] = [b-c] 98758 111041 124853 334652
Value of the Fund at the Year End [e] = [a+d] 892758 1003799 1128652 1128652
RESULT: The value of the fund at the end of 3 years would be Rs. 11.28 Lacs.
E] If the return is @ 21% p.a:
Amount Invested Rs. 794000.00
Interest offered 21.00% 21.00% 21.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 909217 1041154
Interest Income [b] 166740 190936 218642 576318
Tax on Interest Income [c] 51523 58999 67560 178082
Interest ater Tax [d] = [b-c] 115217 131937 151082 398236
Value of the Fund at the Year End [e] = [a+d] 909217 1041154 1192236 1192236
RESULT: The value of the fund at the end of 3 years would be Rs. 11.92 Lacs.
Now back to the place from where we have moved. What should Mr. X do?
If Mr. X is able to earn the return of more than 18.05% p.a., he may conclude that
“PAYING TAX IS BETTER THAN SAVING TAX”
[The Author is a practicing Chartered Accountants & a partner of M/s. SSRPN & CO. Authors may contacted at ca_payal@yahoo.co.in ]
CA. PAYAL MANISH RATHI
THE FACT:
- Long Term Capital Gain (LTCG) is blatantly taxable @ 20%.
- No deduction under Chapter VIA (like u/s 80C towards PPF/LIC/NSC etc) is available against the Long term capital gain.
TAX SAVING OPTIONS:
A tax payers having long term capital gain have the following two options:
- Pay Tax @ 20% or
- Save Tax by investing in Approved mode.
SAVING LTCG TAX U/S 54EC:
One of the most popular tax saving option for all spectrum of tax payers is to save tax by investing the LTCG in the bonds issued by the
- National Highway Authorities of India (NHAI) or
- Rural Electrification Corporation (REC).
This are very commonly referred to as the “54EC Bonds”.
The maximum amount that can be invested in such bonds is Rs. 50 Lacs p.a. Presently, Interest offered by NHAI/REC on this bond is around 6% p.a.
The fund has an opportunity cost. The fund, if not invested in the 54EC bonds, can be utilized elsewhere having higher return perspectives.
The questions remains: Is it worth Investing in the bonds considering such a lower rate of interest offered?
This is particularly more important in the current scenario where
a] Bank FDR offers returns in the range of 9% to 11% p.a.
b] Mutual Funds/ Equity investment offering returns in the range of 15% to 20% p.a.
c] Business or Gold/ Silver or Other Investment yielding more than 20% p.a.
Of the two options available with the tax payer, paying or saving, which is favorable? At what rate of return, paying tax is better than saving tax?
Let us analyze the case of Mr. X who has earned a Long term capital gain of Rs. 10 Lacs during the F.Y. 2010-11. For the sake of simplicity, it is presumed that other income of Mr. X is in 30% tax bracket (i.e., 30.90% with Education Cess).
1st OPTION:
SAVE TAX BY INVESTING IN THE 54EC BONDS:
1. The interest rate offered by the bonds is around 6% p.a.
2. After investment, the Long term capital gain tax liability would be Nil.
3. Mr. X have entire amount of Rs. 10 Lacs to invest in the Bonds.
4. The interest income from this bond is taxable.
5. The value of Rs. 10 Lacs invested on 31.03.2011 @ 6% p.a. would be as under:
Amount Invested Rs. 1000000
Interest offered 6.00% 6.00% 6.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 1000000 1041460 1084639
Interest Income [b] 60000 62488 65078 187566
Tax on Interest Income [c] 18540 19309 20109 57958
Interest ater Tax [d] = [b-c] 41460 43179 44969 129608
Value of the Fund at the Year End [e] = [a+d] 1041460 1084639 1129608 1129608
RESULT: The value of the fund at the end of 3 years would be Rs. 11.29 Lacs.
2nd OPTION:
PAY TAX @ 20% & INVEST THE AMOUNT ELSEWHERE:
If Mr. X pays tax @ 20.60% (including 3% of education cess). He would be required to pay tax of Rs. 2.06 Lacs & would be left with amount of Rs. 7.94 Lacs to invest elsewhere.
The various investments option could be of Investment in:
- Bank FDR with interest in the range of around 9% to 10% or
- Equity Market/ mutual fund or in the business where the yield could vary depending upon the market conditions or the business prospective. Businessmen normally prefer to invest the amount in the business where they may able to earn even more than 20% return on the capital.
Let us compare the value of Rs. 7.94 Lacs invested by Mr. X at different rate
A] If the return is @ 9% p.a.:
Amount Invested Rs. 794000
Interest offered 9.00% 9.00% 9.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 843379 895829
Interest Income [b] 71460 75904 80625 227989
Tax on Interest Income [c] 22081 23454 24913 70448
Interest ater Tax [d] = [b-c] 49379 52450 55712 157541
Value of the Fund at the Year End [e] = [a+d] 843379 895829 951541 951541
RESULT: The value of the fund at the end of 3 years would be Rs. 9.51 Lacs.
B] If the return is @ 12% p.a.:
Amount Invested Rs. 794000.00
Interest offered 12.00% 12.00% 12.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 859838 931136
Interest Income [b] 95280 103181 111736 310197
Tax on Interest Income [c] 29442 31883 34526 95851
Interest ater Tax [d] = [b-c] 65838 71298 77210 214346
Value of the Fund at the Year End [e] = [a+d] 859838 931136 1008346 1008346
RESULT: The value of the fund at the end of 3 years would be Rs. 10.08 Lacs.
C] If the return is @ 15% p.a:
Amount Invested Rs. 794000.00
Interest offered 15.00% 15.00% 15.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 876298 967126
Interest Income [b] 119100 131445 145069 395614
Tax on Interest Income [c] 36802 40617 44826 122245
Interest ater Tax [d] = [b-c] 82298 90828 100243 273369
Value of the Fund at the Year End [e] = [a+d] 876298 967126 1067369 1067369
RESULT: The value of the fund at the end of 3 years would be Rs. 10.06 Lacs.
D] If the return is @ 18% p.a:
Amount Invested Rs. 794000.00
Interest offered 18.00% 18.00% 18.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 892758 1003799
Interest Income [b] 142920 160696 180684 484300
Tax on Interest Income [c] 44162 49655 55831 149648
Interest ater Tax [d] = [b-c] 98758 111041 124853 334652
Value of the Fund at the Year End [e] = [a+d] 892758 1003799 1128652 1128652
RESULT: The value of the fund at the end of 3 years would be Rs. 11.28 Lacs.
E] If the return is @ 21% p.a:
Amount Invested Rs. 794000.00
Interest offered 21.00% 21.00% 21.00%
YEAR I II III TOTAL
Value of the Fund at the beginning of the year [a] 794000 909217 1041154
Interest Income [b] 166740 190936 218642 576318
Tax on Interest Income [c] 51523 58999 67560 178082
Interest ater Tax [d] = [b-c] 115217 131937 151082 398236
Value of the Fund at the Year End [e] = [a+d] 909217 1041154 1192236 1192236
RESULT: The value of the fund at the end of 3 years would be Rs. 11.92 Lacs.
Now back to the place from where we have moved. What should Mr. X do?
If Mr. X is able to earn the return of more than 18.05% p.a., he may conclude that
“PAYING TAX IS BETTER THAN SAVING TAX”
[The Author is a practicing Chartered Accountants & a partner of M/s. SSRPN & CO. Authors may contacted at ca_payal@yahoo.co.in ]
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