Under the Income Tax Act, 1961, capital gains arise when a capital asset is transferred and the sale consideration exceeds the cost of acquisition, adjusted for inflation in certain cases. Capital assets include property, shares, securities and other valuables, excluding stock-in-trade or personal effects like jewelry (except for certain items). The Act classifies capital gains into short-term capital gains (STCG) and long-term capital gains (LTCG), depending on the holding period of the asset.
For most assets, if held for more than 24 months (36 months for unlisted shares or immovable property prior to amendments), the gains qualify as LTCG. STCG is taxed at the assessee's applicable slab rates while LTCG is generally taxed at 20% with indexation benefits for assets like property, or 12.5% without indexation for certain assets post recent budgets. However, the Act provides several exemptions to mitigate this tax burden, encouraging reinvestment in specified avenues. Section 54EC allows exemption on LTCG by investing in "capital gain bonds." This mechanism is especially relevant for assessees dealing with gains from immovable property sales, promoting infrastructure development through investments in government-backed bonds.
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Exemptions under Capital Gain Bonds Provisions
The Act offers multiple exemptions under Chapter VIA for capital gains, each tailored to specific scenarios. For instance, Section 54 exempts LTCG from residential property sales if reinvested in another residential house. Section 54F extends similar benefits for non-residential assets, provided the gains are used to purchase or construct a house. Section 54B targets agricultural land reinvestments.
Section 54EC, however, stands out as it applies broadly to LTCG from land or buildings (post-2018 amendments) and directs investments towards infrastructure bonds. Introduced to channel funds into national development projects, it was initially available for any long-term capital asset but was restricted in the Finance Act, 2018, to gains from land or buildings only. This change aimed to curb exemptions on financial assets like shares, aligning with the removal of LTCG exemptions under Section 10(38) for equity shares.
The rationale behind these exemptions is twofold i.e. to provide tax relief to assessees and stimulate economic sectors like housing and infrastructure. These provisions are interpreted strictly, as exemptions are concessions from the general rule of taxation, and courts often apply the literal rule unless ambiguity arises.
Benefits and Drawbacks
Benefits include full tax deferral (up to Rs. 50 lakhs), secure investments in government entities, and contribution to infrastructure. For high-net-worth individuals selling property, it's a straightforward tax-saving tool without needing to buy another asset.
Drawbacks: Low interest rates (5-6%) compared to market alternatives, five-year lock-in reducing liquidity, and taxable interest. Post-2018, it's unavailable for share sales, limiting scope. Inflation erodes real returns, making it suitable only for risk-averse assessees.
Recent Developments as of July 2025
The Finance Act, 2025 introduced Clause 85 which reinforces non-taxation on certain bond investments though specifics align with existing frameworks. Other updates include HUDCO's inclusion from April 2025 for infrastructure and IREDA from July 2025 for renewables, reflecting the government push towards sustainable development.
No major structural changes in Budget 2025, but these additions broaden choices. Practitioners should monitor CBDT notifications for further issuers.
Detailed Provisions of Section 54EC
Section 54EC of the Act provides that where LTCG arises from the transfer of a long-term capital asset (specifically land or building or both, since April 1, 2018), and the assessee invests the whole or part of such gains in "long-term specified assets" within six months from the transfer date, the invested amount is exempt from tax.
The key subsections are:
Subsection (1): If the cost of the specified asset equals or exceeds the capital gain, the entire gain is exempt. If less, a proportionate exemption applies.
Provisos: Investments in any financial year are capped at Rs. 50 lakhs. If the bond is transferred or converted into money within five years (previously three years, amended in 2018), the exempt gain becomes taxable as LTCG in that year.
Explanation: "Long-term specified asset" means bonds redeemable after five years, issued by entities like the National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC), or other notified bonds.
This provision does not allow indexation on the bond investment itself for future gains, and interest from bonds is taxable as income from other sources. For legal analysis, note that the six-month period is computed from the date of transfer, not receipt of consideration, as clarified in various judicial pronouncements.
Read about Transfer of Shares in Companies Act, 2013.
Eligible Assets and Capital Gain Bonds
The original asset must be a long-term capital asset, specifically land or building (including depreciable assets under Section 50). Pre-2018, it included any asset but the amendment restricted it to immovable property to prevent misuse in financial markets.
Eligible bonds, notified by the Central Government, include:
NHAI Capital Gain Bonds
REC Capital Gain Bonds
Power Finance Corporation (PFC) Bonds
Indian Railway Finance Corporation (IRFC) Bonds
Recent notifications have expanded this list. As of April 1, 2025, Housing and Urban Development Corporation (HUDCO) bonds issued post that date qualify, earmarked for infrastructure projects. Further, effective July 9, 2025 Indian Renewable Energy Development Agency (IREDA) bonds have been granted Section 54EC status, promoting green energy investments. These bonds offer around 5-5.75% annual interest, paid annually or cumulatively, and are AAA-rated for security.
For practitioners, advising clients on bond selection involves assessing credit ratings, interest rates, and alignment with national priorities like renewable energy via IREDA.
Learn about more Income Tax Rules.
Conditions and Time Limits
To claim exemption the following things should be taken into consideration. Non-compliance leads to the gain being taxed at 20% (or 12.5% without indexation for property post-2023 amendments). Assessees must file returns claiming this under Schedule CG, supported by bond certificates:
Investment Timeline: Within six months from the transfer date. If the last day falls on a holiday, it extends to the next working day, per judicial interpretations.
Investment Limit: Maximum Rs. 50 lakhs per financial year, but if the transfer spans two FYs, the limit applies across both.
Lock-in Period: Five years; premature withdrawal triggers tax on the exempt gain.
Mode of Investment: Directly in bonds i.e. loans against bonds are treated as conversion, revoking exemption.
Calculation of Exemption with Examples
The exemption is computed as:
Exempt Amount = (Investment in Bonds / Total LTCG) × LTCG
Example: Mr. A sells land for Rs. 1 crore, with indexed cost Rs. 60 lakhs, yielding LTCG of Rs. 40 lakhs. He invests Rs. 30 lakhs in NHAI bonds within six months.
Exempt: (30/40) × 40 = Rs. 30 lakhs
Taxable: Rs. 10 lakhs @ 20% with indexation.
If invested Rs. 50 lakhs (exceeding gain), full Rs. 40 lakhs exempt, but limit caps at Rs. 50 lakhs.
For partial investments, proportionality applies. Legal disputes often arise on "transfer date" in installment sales, resolved by considering the date possession is handed over.
Summary
Capital gain bonds which are governed by Section 54EC of the Income Tax Act, 1961, offer a tax-saving option for long-term capital gains (LTCG) from selling land or buildings. By investing the gains in specified bonds within six months of the sale, individuals can exempt up to ₹50 lakhs of LTCG from tax per financial year. Eligible bonds, issued by entities like NHAI, REC, PFC, IRFC, HUDCO (from April 2025), and IREDA (from July 2025), are government-backed, AAA-rated, and support infrastructure and renewable energy projects. These bonds have a five-year lock-in period, and premature withdrawal or loans against them make the exempted gain taxable. They offer 5-5.75% annual interest, taxable as income from other sources. While secure and tax-efficient, their low returns and long lock-in may limit appeal for those seeking higher yields or liquidity. Assessees must file returns with bond certificates to claim the exemption, ensuring compliance with strict timelines.
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Capital Gain Bonds: FAQs
Q1. Are bonds exempt from capital gains tax?
Investing in capital gain bonds under Section 54EC can exempt long-term capital gains tax up to ₹50 lakhs if invested within 6 months of selling land or a building.
Q2. What is the lock-in period for capital gains bonds?
The lock-in period for capital gain bonds is 5 years; selling or borrowing against them before this makes the exempted gain taxable.
Q3. What is the best bond for capital gains tax exemption?
NHAI, REC, PFC, IRFC, HUDCO, or IREDA bonds are equally good for Section 54EC exemption, chosen based on availability and issuer reliability.
Q4. What is the interest rate on capital gains tax bonds?
Capital gain bonds typically offer 5-5.75% annual interest, paid yearly or at maturity, depending on the issuer like NHAI or REC.
