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Enjoy exemption from long term capital gains by planning investment in specified bonds!

               Section 54EC of the Income-tax Act provides for exemption of taxable long term capital gains (LTCG) arising from the transfer of an asset, to the extent the amount of such gains are invested in notified bonds within a period of six months from the date of transfer.  Notified for this purpose are the three year bonds issued by National Highways Authority of India (NHAI) and Rural Electrification Corporation (REC).

               Until FY 2006-07, there was no monetary ceiling prescribed in regard to investment in such capital gains bonds and hence a taxpayer could virtually invest his entire taxable gain, even running into crores of rupees, in these bonds and avail the benefit of 100% exemption under Section 54EC.

               However, the Finance Act, 2007 amended Section 54EC so as to provide that this exemption would be available subject to the condition that the investment in the notified capital gains bonds made on or after 1st day of April, 2007 does not exceed Rs.50,00,000 during any financial year.

               Does this mean that every taxpayer earning more than Rs.50,00,000 by way of taxable LTCG on sale of property would have no option but to give away income-tax at the rate of 20.6% on the amount earned over Rs.50,00,000? Probably not, if he has planned the timing of his sale and bond investment as the case study below illustrates.

Case Study: Sonu Nigam is planning to sell his house for a sale consideration of Rs.1,80,00,000 in August, 2011. He had acquired the same by way of inheritance in 2005 from his father, who held the property since 1970. As per Section 49 read with Section 55(2), Sonu can adopt the fair market value (FMV) as on 1st April, 1981 as his cost of acquisition and further avail the benefit of indexation under Section 48. The FMV of the property on 1-4-81 as per the report of a registered valuer has been certified at Rs.10,00,000. Applying the notified cost inflation index of 785 for FY 2011-12, the indexed cost of the property would be Rs.78,50,000 and on the basis of the same, the taxable LTCG would work out to Rs.1,01,50,000.

Sonu needs to bear in mind that the monetary ceiling of Rs.50,00,000, under Section 54EC, is not in relation to a transaction, but the same is with reference to a financial year. In view of the same, if Sonu plans to defer the sale of house anytime after October, 2011, he can invest Rs.50,00,000 before March, 2012 and another Rs.50,00,000 in April, 2012, thus ensuring that Rs.50,00,000 each are invested in two separate FYs 2011-12 and 2012-13, but within the prescribed time limit of six months from the date of transfer. He would thus be eligible to effectively claim exemption of Rs.1,00,00,000 under Section 54EC and avail of the maximum tax saving. If, however, Sonu sells his house before 30th September, 2011, his effective exemption under Section 54EC would be restricted to only Rs.50,00,000. Just some smart timing and Sonu can save a healthy Rs.10,30,000 by way of long term capital gains tax (at 20.6% on Rs.50,00,000).


             Income-tax Appellate Tribunals have been liberal in their judicial interpretations while dealing with issues relating to the provisions of Section 54EC holding that “a beneficial section has to be construed liberally, having due regard to the object which it intends to serve.” The following decisions in this regard can be usefully relied upon by taxpayers:

             In the case of Bhikhulal Chandak (HUF) v/s. ITO (126 TTJ 545) the ITAT Nagpur Bench has held that where a taxpayer has deposited the advance received by him under the agreement for sale in the prescribed bonds under Section 54EC, he cannot be denied the benefit of exemption on the technical count that such investment is required to be made only within a period of six months after the date of sale.

            The ITAT Delhi Bench, in the case of ITO v/s. Smt. Saraswati Ramnathan 116 ITD 234 was required to consider a case where a taxpayer had made investment in her name, jointly with her son. Her claim for exemption was negatived by the Assessing Officer on the ground that the investment was in joint names, which was not permitted under Section 54EC. The Tribunal held that there is no requirement under this Section that investment should be in name of the taxpayer and the only condition is that sale proceeds of capital assets must be invested in specified bonds. The sound logic of the author of this decision, currently President of the ITAT, Shri R.V. Easwar, for reaching to his judicious conclusion merits an appreciative reading:

            “Normally, when an investment is made, particularly if it is made by a person of an advanced age, precautions are taken to include another name. The object of doing so is merely to avoid any problem in future, in case anything untoward should happen to the investor. It is difficult to imagine that it would have been the intention of the Act to place restrictions on such freedom given to the citizens of the country or on their right to take such precautions in the interests of a secure future. Income-tax is only one aspect of life, and that too for a minuscule part of the citizens of this country. While everyone is given the freedom to make investments in any name he likes, there is no reason why such freedom should be taken away in the case of the income-tax payers, when the substantial ingredients of the Section are complied with and the sale proceeds of the capital asset are channelled into the assets in the national interest which is the main and vital requirement of the Section. In any case, the provisions of the Act cannot be interpreted in an unreasonable manner, for tax laws like all other laws, have to be interpreted reasonably and in consonance with justice.”

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