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Thursday, April 19, 2012

Indexation and Capital Gain Bonds

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Sachin bought one property for Rs.15 Lac in 2005 and sold for Rs.30 Lakh in 2011.

Numerically his capital gain is: 30 lac – 15 Lac

= Rs.15 Lac.

Its only a numerical capital gain as cost of inflation is not inclusive of it and indexation is broadly related to inclusive of inflation effects in calculation of capital gain. The government comes out with an index number each year to facilitate the calculation of capital gain.

For example we can consider capital gains across Debt mutual funds. These funds  have indexation benefits. Suppose investors bought units of debt mutual fund at NAV of 10 in 2008 and sold them in 2011 with an NAV of 15.

Suppose that government inflation index was 400 in 2008 and its 520 in the year 2011.

Now investor have two options to consider while calculating the long term capital gain tax:

A)10% without indexation:

= (10/100) x (15 – 10)

=Rs. 0.5 per unit.

B) 20% with indexation:

Indexed cost of acquisition based on inflation index is

=purchase NAV  x (Inflation index at the time of buying of units / index in year of selling of units)

= 10 x (520/400)

= 13.

And now capital gain with indexation benefits is:

=20/100  x (15-13)

=Rs.0.4 per unit.

The investor would pay lower tax between two options. Its not the case that always tax with indexation benefits is lower but it depends upon inflation between two points. but more higher is the period possibility of higher inflation   and indexation benefits are there.

Capital Gain Bonds:

Investor can save long term capital gain tax by investing in the capital gain bonds under section 54EC of income tax act 1961.

Key features about above issues are:

1. Bonds are secured and highly rated by CRISIL "AAA " and FITCH AAA.

2. Interest rate is 6% payable annually.

3. Min application amount: Rs.10,000 / 1 Bond.

4. Max. application amount: 500 bonds.

5. Date of allotment: Last day of month in which money is credited.

6. Tenor: 3 Yrs.

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